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Tournaments versus Piece Rates under Limited Liability

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  • Kräkel, Matthias

Abstract

Lecture on the first SFB/TR 15 meeting, Gummersbach, July, 18 - 20, 2004The existing literature on the comparison of tournaments and piece rates as alternative incentive schemes has focused on the case of unlimited liability. However, in practice real workers’ wealth is typically restricted. Therefore, this paper compares both schemes under the assumption of limited liability. The results show that if the cost function is sufficiently convex, first-best effort will be more likely implemented under piece rates than under tournaments. Moreover, if first-best implementation is not achieved and workers earn positive rents, efforts and profits will be larger for piece rates than for tournaments given sufficiently convex costs. While tournaments offer a partial insurance due to their fixed prizes, piece rates may not work any longer if potential losses become prohibitively high. Finally, if risk is sufficiently high, piece rates will dominate tournaments despite the partial insurance effect of tournament compensation. Since effort costs and risk may depend on an individual worker’s characteristics, on the characteristics of his job and on his hierarchical position, these findings have important implications for the choice of incentive schemes and the allocation of workers in firms.

Suggested Citation

  • Kräkel, Matthias, 2004. "Tournaments versus Piece Rates under Limited Liability," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 15, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  • Handle: RePEc:trf:wpaper:15
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    File URL: https://epub.ub.uni-muenchen.de/13533/1/15.pdf
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    References listed on IDEAS

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    1. Lazear, Edward P & Rosen, Sherwin, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 841-864, October.
    2. George Baker & Michael Gibbs & Bengt Holmstrom, 1994. "The Wage Policy of a Firm," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 921-955.
    3. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
    4. Bognanno, Michael L, 2001. "Corporate Tournaments," Journal of Labor Economics, University of Chicago Press, vol. 19(2), pages 290-315, April.
    5. Pitchford, Rohan, 1998. "Moral hazard and limited liability: The real effects of contract bargaining," Economics Letters, Elsevier, vol. 61(2), pages 251-259, November.
    6. Edward P. Lazear, 2000. "Performance Pay and Productivity," American Economic Review, American Economic Association, vol. 90(5), pages 1346-1361, December.
    7. Green, Jerry R & Stokey, Nancy L, 1983. "A Comparison of Tournaments and Contracts," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 349-364, June.
    8. Eriksson, Tor, 1999. "Executive Compensation and Tournament Theory: Empirical Tests on Danish Data," Journal of Labor Economics, University of Chicago Press, vol. 17(2), pages 262-280, April.
    9. Richard B. Freeman & Morris M. Kleiner, 1998. "The Last American Shoe Manufacturers: Changing the Method of Pay to Survive Foreign Competition," NBER Working Papers 6750, National Bureau of Economic Research, Inc.
    10. Knoeber, Charles R & Thurman, Walter N, 1994. "Testing the Theory of Tournaments: An Empirical Analysis of Broiler Production," Journal of Labor Economics, University of Chicago Press, vol. 12(2), pages 155-179, April.
    11. Ehrenberg, Ronald G & Bognanno, Michael L, 1990. "Do Tournaments Have Incentive Effects?," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1307-1324, December.
    12. James M. Malcomson, 1986. "Rank-Order Contracts for a Principal with Many Agents," Review of Economic Studies, Oxford University Press, vol. 53(5), pages 807-817.
    13. Dominique Demougin & Claude Fluet, 2003. "Inequity Aversion in Tournaments," Cahiers de recherche 0322, CIRPEE.
    14. Bull, Clive & Schotter, Andrew & Weigelt, Keith, 1987. "Tournaments and Piece Rates: An Experimental Study," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 1-33, February.
    15. George Baker & Michael Gibbs & Bengt Holmstrom, 1994. "The Internal Economics of the Firm: Evidence from Personnel Data," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 881-919.
    16. Malcomson, James M, 1984. "Work Incentives, Hierarchy, and Internal Labor Markets," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 486-507, June.
    17. Park, Eun-Soo, 1995. "Incentive Contracting under Limited Liability," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(3), pages 477-490, Fall.
    18. Son Ku Kim, 1997. "Limited Liability and Bonus Contracts," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 6(4), pages 899-913, December.
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    Cited by:

    1. Derek J. Clark & Kai A. Konrad, 2007. "Contests with Multi-tasking," Scandinavian Journal of Economics, Wiley Blackwell, vol. 109(2), pages 303-319, June.
    2. James W. Bono, 2008. "Sales contests, promotion decisions and heterogeneous risk," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 29(4), pages 371-382.

    More about this item

    Keywords

    incentives; limited liability; piece rates; rank-order tournaments;

    JEL classification:

    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • M5 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics

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