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Relative Performance Pay, Bonuses, and Job-Promotion Tournaments

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  • Kräkel, Matthias
  • Schöttner, Anja

Abstract

Several empirical studies have challenged tournament theory by pointing out that (1) there is considerable pay variation within hierarchy levels, (2) promotion premiums only in part explain hierarchical wage differences and (3) external recruitment is observable on nearly any hierarchy level. We explain these empirical puzzles by combining job-promotion tournaments with higher-level bonus payments in a two-tier hierarchy. Moreover, we show that under certain conditions the firm implements first-best effort on tier 2 although workers earn strictly positive rents. The reason is that the firm can use second-tier rents for creating incentives on tier 1. If workers are heterogeneous, the firm strictly improves the selection quality of a job-promotion tournament by employing a hybrid incentive scheme that includes bonus payments.

Suggested Citation

  • Kräkel, Matthias & Schöttner, Anja, 2008. "Relative Performance Pay, Bonuses, and Job-Promotion Tournaments," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 245, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  • Handle: RePEc:trf:wpaper:245
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    References listed on IDEAS

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    1. Dominique M. Demougin & Devon A. Garvie, 1991. "Contractual Design with Correlated Information under Limited Liability," RAND Journal of Economics, The RAND Corporation, vol. 22(4), pages 477-489, Winter.
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    More about this item

    Keywords

    bonuses; external recruitment; job promotion; limited liability; tournaments;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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