Hidden Benefits of Reward: A Field Experiment on Motivation and Monetary Incentives

Abstract:

We conducted a field experiment in a controlled work environment to investigate the effect of motivational talk and its interaction with monetary incentives. We find that motivational talk significantly improves performance only when accompanied by performance pay. Moreover, performance pay slightly reduces performance unless it is accompanied by motivational talk. These effects also carry over to the quality of work. Performance pay alone leads to more mistakes. Adding motivational talk makes the difference. In treatments with performance pay, motivational talk increases output by about 20 percent and reduces the ratio of mistakes by more than 40 percent.

JEL Classification: C93, M52, J33

Keywords: Verbal Motivation, Performance Pay, Field Experiment

Full text in pdf format:

451.pdf

Verifiable and Nonverifiable Information in a Two-Period Agency Problem

Abstract:

I examine how a firm’s opportunity to verify information influences the joint use of verifiable and unverifiable information for incentive contracting. I employ a simple two-period agency model, in which contract frictions arise from limited liability and the potential unverifiability of the principal’s information about the agent’s action. With short-term contract, the principal benefits from both a more informative and a more conservative verification of his private information. With long-term contracts, he may prefer a less informative verification, but his preference for a conservative verification persists.

Full text in pdf format:

445.pdf

Good news and bad news in subjective performance evaluation

Abstract:

Earlier studies show that contracts under subjective performance evaluation are dichotomous and punish only worst performance. I show that with limited liability payments need not be binary. More importantly, if the agent earns a rent from limited liability, the optimal contract distinguishes only signals of good news and bad news of the agent’s action.

Keywords: bonus, monotone likelihood ratio, wage compression

JEL classification numbers: D82, M52, M54

Full text in pdf format:

444.pdf

Dynamic Bonus Pools

Abstract:

We analyze a two-period agency problem with limited liability and nonverifiable information. The principal commits to a dynamic bonus pool comprising a fixed total payment that may be distributed over time to the agent and a third party. We find that the optimal two-period contract features memory. If the agent succeeds in the first-period, second-period incentives are weakened whereas higher-powered incentives are provided if he fails. The two-period bonus pool offers a complementary reason for why third-party payments are not commonly observed in practice.

Full text in pdf format:

443.pdf

Relative Performance Pay in the Shadow of Crisis

Abstract:

We analyze whether incentives from relative performance pay are reduced or enhanced if a department is possibly terminated due to a crisis. Our benchmark model shows that incentives decrease in a severe crisis, but are boosted given a minor crisis since efforts are strategic complements in the former case but strategic substitutes in the latter one. We tested our predictions in a laboratory experiment. The results confirm the effort ranking but show that in a severe crisis individuals deviate from equilibrium significantly stronger than in other situations. This behavior contradicts the benchmark model and leads to a five times higher survival probability of the department. We develop a new theoretical approach that may explain players’ behavior.

Keywords: crisis; incentives; strategic complements; strategic substitutes; tournament

JEL Classification: C9; J3; J6; M5

Full text in pdf format:

425.pdf

Externalities in Recruiting

Abstract:

External recruiting at least weakly improves the quality of the pool of applicants, but the incentive implications are less clear. Using a contest model, this paper investigates the pure incentive effects of external recruiting. Our results show that if workers are heterogeneous, the opening of a firm’s career system may lead to a homogenization of the pool of contestants and, thus, encourage the firm’s high ability workers to exert more effort. If this positive effect outweighs the discouragement of low ability workers, the firm will benefit from external recruiting. If, however, the discouragement effect dominates the homogenization effect, the firm should disregard external recruiting. In addition, product market competition makes opening of the career system less attractive for a firm since it increases the incentives of its competitors’ workers and hence strengthens the competitors.

Keywords: contest; externalities; recruiting; wage policy.

JEL Classification: C72; J2; J3.

Full text in pdf format:

414.pdf

Bonus Pools and the Informativeness Principle

Abstract:

Previous work on moral-hazard problems has shown that, under certain conditions, bonus contracts create optimal individual incentives for risk-neutral workers. In our paper we demonstrate that, if a firm employs at least two workers, it may further bene.t from combining worker compensation via a bonus-pool contract and relative performance evaluation. Such combination leads to saved rents under a wide class of luck distributions. In addition, if the employer is wealth-constrained, complementing individual bonus contracts by the possibility of pooling bonuses can increase the set of implementable effort levels. All our results hold even though workers’ outputs are technically and stochastically independent so that, in view of Holmstrom’s informativeness principle, individual bonus contracts would be expected to dominate bonus-pool contracts.

Keywords: contract; hazard rate; informativeness principle; limited liability; relative

performance.

JEL classification: C72; D86.

Full text in pdf format:

413.pdf

Authority and Incentives in Organizations

Abstract:

The paper analyzes the choice of organizational structure as solution to the trade-off between controlling behavior based on authority rights and minimizing costs for implementing high efforts. The analysis includes the owner of a firm, a top manager and two division heads. If it is more expensive to incentivize the division heads, the owner will prefer full delegation of authority to them to replace their high incentive pay by incentives based on private benefits of control. In that situation, decentralization is optimal given that selfish behavior is more important than cooperation for maximizing returns, but concentrated delegation of full authority to a single division head is optimal for cooperation being crucial. If, however, incentivizing the division heads is clearly less expensive than creating incentives for the top manager, the owner will choose centralization given that cooperation is the dominating issue, but partial delegation if selfish behavior is crucial.

Keywords: authority, centralization, contracts, decentralization, moral hazard.

JEL classification: D21, D23, D86, L22.

Full text in pdf format:

412.pdf

Tournaments with Gaps

Abstract:

A standard tournament contract specifies only tournament prizes. If agents’ performance is measured on a cardinal scale, the principal can complement the tournament contract by a gap which defines the minimum distance by which the best performing agent must beat the second best to receive the winner prize. We analyze a tournament with two risk averse agents. Under unlimited liability, the principal strictly benefits from a gap by partially insuring the agents and thereby reducing labor costs. If the agents are protected by limited liability, the principal sticks to the standard tournament.

Keywords: limited liability; moral hazard; risk aversion; tournament; unlimited liability.

JEL classification: C72; D86.

Full text in pdf format:

411.pdf

Merger Efficiency and Managerial Incentives

Abstract:

We consider a two-stage principal-agent model with limited liability in which a CEO is employed as agent to gather information about suitable merger targets and to manage the merged corporation in case of an acquisition. Our results show that the CEO systematically recommends targets with low synergies—even when targets with high synergies are available—to obtain high-powered incentives and, hence, a high personal income at the merger-management stage. We derive conditions under which shareholders prefer a self-commitment policy or a rent-reduction policy to deter the CEO from opportunistic recommendations.

JEL classification: D82; D86; G34

Keywords: acquisition; merger; moral hazard

Full text in pdf format:

410.pdf

Repeated moral hazard and contracts with memory: A laboratory experiment

Abstract:

This paper reports data from a laboratory experiment on two-period moral hazard problems. The findings corroborate the contract-theoretic insight that even though the periods are technologically unrelated, due to incentive considerations principals can benefit from offering long-term contracts that exhibit memory.
Keywords: Repeated moral hazard; Sequential hidden actions; Laboratory experiment
JEL classification: D82; J33

Full text in pdf format:

372.pdf

Overconfidence and Managers’ Responsibility Hoarding

Abstract:

Overconfidence is a well-established behavioral phenomenon that involves an overestimation of own capabilities. We introduce a model, in which managers and agents exert effort in a joint production, after the manager decides on the allocation of the tasks. A rational manager tends to delegate the critical task to the agent more often than given by the efficient task allocation. In contrast, an overconfident manager is more likely to hoard responsibility, i.e. to delegate the critical task less often than a rational manager. In fact, a manager with a sufficiently high ability and a moderate degree of overconfidence increases
the total welfare by hoarding responsibility and exerting more effort than a rational manager. Finally, we derive the conditions under which responsibility hoarding can persist in an organization, showing that the bias survives as long as the overconfident manager can rationalize the observed output by underestimating the ability of the agent.
Key Words: organizational behavior, management performance, bounded rationality, behavioral bias
JEL classification: C72, D03, D82, M12, M54

Full text in pdf format:

368.pdf

Heterogeneous Contestants and Effort Provision in Tournaments - an Empirical Investigation with Professional Sports Data

Abstract:

We empirically investigate if tournaments between heterogeneous contestants are less intense. To test our hypotheses we use professional sports data from the TOYOTA Handball-Bundesliga, the major handball league in Germany. Using either differences in betting odds or rankings to measure ability differences, our results support standard tournament theory as we find a highly significant negative impact of the matchup's heterogeneity on joint teame efforts. However, further analysis shows that this overall decrease in efforts is almost entirely driven by the reaction of the ex-ante favorite team.

Keywords: tournament, heterogeneity, incentives, sportseconomics

JEL Classification: J24, J33, J41, M52

July 2010

Full text in pdf format:

325.pdf

Incentive Effects in Asymmetric Tournaments Empirical Evidence from the German Hockey League

Abstract:

Following tournament theory, incentives will be rather low if the contestants of  a tournament are heterogeneous. We empirically test this prediction using a  large dataset from the German Hockey League. Our results show that indeed the intensity of a game is lower if the teams are more heterogeneous. This effect can be observed for the game as a whole as well as for the ?rst and last third. When dividing the teams in the dataset into favorites and underdogs, we only observe a reduction of effort provision from favorite teams. As the number of games per team changes between different seasons, we can also investigate the effect of a changing spread between winner and loser prize. In line with theory, teams reduce effort if the spread declines. Interestingly, effort is also sensitive to the total number of teams in the league even if the price spread remains unchanged.

Keywords: Tournaments, Heterogeneity, Incentives,Effort

JEL Classification: J33

January 2010

Full text in pdf format:

305.pdf

Competitive Careers as a Way to Mediocracy

Abstract:

We show that incompetitive careers based on individual performance the least productive individuals may have the highest probabilities to be promoted to top positions. These individuals have the lowest fall-back positions and, hence, the highest incentives to succeed in career contests. This detrimental incentive effect exists irrespective of whether effort and talent are substitutes or complements in the underlying contest-success function. However, in case of complements the incentive effect may be be outweighed by a productivity effect that favors high    effort choices by the more talented individuals.

Key Words: career competition; contest; mediocracy
JEL Classification: D72; J44; J45; M51

November 2009

Full text in pdf format:

286.pdf

Sabotage in dynamic tournaments

Abstract:

This paper studies sabotage in a dynamic tournament. Three players compete in two rounds. In the final round, a player who is leading in the race, but not yet beyond the reach of his competitors, gets sabotaged more heavily. As a consequence, if players are at the same position initially, they do not work productively or sabotage at all in the first round. Thus sabotage is not only directly destructive, but also depresses incentives to work productively. If players are heterogeneous ex ante, sabotage activities in the first round may be concentrated against an underdog, contrary to findings from static tournaments. We also discuss the robustness of our results in a less stylized environment.

Keywords: dynamic tournaments, contests, sabotage, heterogeneity

June 2009

Full text in pdf format:

266.pdf

Minimum Wages and Excessive Effort Supply

Abstract:

It is well-known that, in static models, minimum wages generate positive worker rents and, consequently, inefficiently low effort. We show that this result does not necessarily extend to a dynamic context. The reason is that, in repeated employment relationships, firms may exploit workers’ future rents to induce excessively high effort.

Keywords: bonuses; limited liability; minimum wages

JEL Classification: D82; D86; J33

June 2009

Full text in pdf format:

264.pdf

Relative Performance Pay, Bonuses, and Job-Promotion Tournaments

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.

Keywords: bonuses, external recruitment, job promotion, limited liability, tournaments
JEL Classification: D82, D86, J33
September 2008

Full text in pdf format:

245_01.pdf

Optimal Contracts for Lenient Supervisors

Abstract:

We consider a situation where an agent's effort is monitored by a supervisor who cares for the agent's well being. This is modeled by incorporating the agent's utility into the utility function of the supervisor. The first best solution can be implemented even if the supervisor's preferences are unknown. The corresponding optimal contract is similar to what we observe in practice: The supervisor's wage is constant and independent of his report. It induces one type of supervisor to report the agent's performance truthfully, while all others report favorably independent of performance. This implies that overstated performance (leniency bias) may be the outcome of optimal contracts under informational asymmetries.

Keywords: Subjective performance evaluation, leniency, supervisor, private infrmation
JEL Classification: D82, D86, J33, M52
June 2008

Full text in pdf format:

237.pdf

Optimal Tournament Contracts for Heterogeneous Workers

Abstract:

We analyze the optimal design of rank-order tournaments with heterogeneous workers. Iftournament prizes do not differ between the workers(uniform prizes), as in the previous tournament literature, the outcome will be ineffcient. In the case of limited liability, the employer may benefit from implementing more than first-best effort. We show that the employer can use individual prizes that satisfy a self-commitment condition and induce effcient incentives at the same time, thus solving a fundamental dilemma in tournament theory. Individual prizes exhibit two major advantages - they allow the extraction of worker rents and the adjustment of individual incentives, which will be important for the employer if he cannot rely on handicaps.

Keywords: heterogenous workers, limited liability,rank-order tournaments, self commitment
JEL Classification: J33,M12, M52
May 2008

Full text in pdf format:

234.pdf

Risk Taking in Winner-Take-All Competition

Abstract:

We analyze a two-stage game between two heterogeneous players. At stage one, common risk is chosen by one of the players. At stage two, both players observe the given level of risk and simultaneously invest in a winner-take-all competition. The game is solved theoretically and then tested by using laboratory experiments. We find three effects that determine risk taking at stage one - an effort effect, a likelihood effect and a reversed likelihood effect. For the likelihood effect, risk taking and investments are clearly in line with theory. Pairwise comparison shows that the effort effect seems to be more relevant than the reversed likelihood effect when taking risk.

Keywords: Tournaments, Competition, Risk-Taking, Experiment
JEL Classification: M51, C91, D23
March 2008

Full text in pdf format:

233.pdf

Limited Liability and the Risk-Incentive Relationship

Abstract:

Several empirical ?ndings have challenged the traditional view on the trade-off between risk and incentives. By combining risk aversion and limited liability in a standard principal-agent model the empirical puzzle on the positive relationship between risk and incentives can be explained. Increasing risk leads to a less informative performance signal. Under limited liability, the principal may optimally react by increasing the weight on the signal and, hence, choosing higher-powered incentives.

Keywords: moral hazard, limited liability, risk-incentive relationship
JEL Classification: D82, D86
March 2008

Full text in pdf format:

232.pdf

Feedback in Tournaments under Commitment Problems: The-ory and Experimental Evidence

Abstract:

In this paper, we analyze a principal's optimal feedback policy in tournaments. We close a gap in the literature by assuming the principal to be unable to commit to a certain policy at the beginning of the tournament. Our analysis shows that in equilibrium the principal reveals in-termediate information regarding the agents’ previous performances if these performances are not too different. Moreover, we investigate a situation where the principal is not able to credi-bly communicate her information. Having presented our formal analysis, we test these results using data from laboratory experiments. The experimental findings provide some support for the model.

Keywords: tournament, commitment problems, feedback, experiment
JEL Classification: C 91, D 83, J 33, M 52

October 2007

Full text in pdf format:

219.pdf

Double-Sided Moral Hazard, Efficiency Wages and Litigation

Abstract:

We consider a double-sided moral hazard problem where each party can renege on the signed contract since there does not exist any verifiable performance signal. It is shown that ex-post litigation can restore incentives of the agent. Moreover, when the litigation can be settled by the parties the pure threat of using the legal system may suffice to make the principal implement first-best effort. As is shown in the paper, this .finding is rather robust. In particular, it holds for situations where the agent is protected by limited liability, where the parties have different technologies in the litigation contest, or where the agent is risk averse.

Keywords: double-sided moral hazard, efficiency wage, litigation, contest, settlement
JEL Classification: D86, J33, K41

September 2007

Full text in pdf format:

214.pdf

Short-term or long-term contracts? - A rent-seeking perspective

Abstract:

In this paper, .rms engage in rent seeking in order to be assigned a governmental contract. We analyze how a change in the contract length a¤ects the .rms. rent-seeking behavior. A longer contract leads to more rent seeking at a contract assignment stage, as the .rms value the contract higher. On the other hand, the contract has to be assigned less often, which of course leads to less rent seeking. Finally, a longer contract makes a possible cooperation between the .rms solving the rent-seeking problem more difficult to sustain.

Keywords: Contract length, rent seeking, cooperation, relational contract
JEL Classification: D72, D74

Full text in pdf format:

208.pdf

Variance analysis and linear contracts in agencies with distorted performance measures

Abstract:

This paper investigates the role of variance analysis procedures in aligning objectives under the condition of distorted performance measurement. A riskneutral agency with linear contracts is analyzed, whereby the agent receives postcontract, pre-decision information on his productivity. If the performance measure is informative with respect to the agent’s marginal product concerning the principal’s objective, variance investigation can alleviate effort misallocation. These results carry over to a participative budgeting situation, but in this case the variance investigation procedures are less demanding.

April 2007

Full text in pdf format:

206.pdf

Bonus Pools, Limited Liability, and Tournaments

Abstract:

Tournaments have been objected as resulting from ad hoc restrictions to the contracting problem which are not easily justified. Taking into account that a performance measure might not be verifiable to a third party, however, a restriction to payments which sum up to a constant may be reasonable. The paper analyzes such fixed payment schemes with regard to their optimality and the relation to the special case of tournaments. It emerges that for a group of identical risk-neutral agents, the optimal fixed payment scheme is a tournament.

Keywords: bonus pools, relative performance evaluation, subjective performance evaluation, tournaments, verifiability
JEL classification: D82, M52, M54
March 2007

Full text in pdf format:

205.pdf

Performance measure congruity in linear agency models with interactive tasks

Abstract:

This note demonstrates how performance measure congruity and noise determine an agency’s total surplus within an linear agency framework with multiple tasks. It provides a decomposition of agency costs, leading back to a congruity index previously proposed in the literature. In addition, it generalizes this index to a more general cost function, thereby highlighting the context specificity of the original criterion. Finally, it suggests a redefinition of tasks under which the criterion prevails.

Keywords: incentives, multi-tasking, performance measurement
JEL classification: D82, M52
November 2006

Full text in pdf format:

204.pdf

Distorted performance measurement and relational contracts

Abstract:

This paper analyzes the use of alternative performance measures in an agency model in which contracting incorporates both formal and informal agreements. It is shown that under a proper use of verifiable and unverifiable performance measures, the two types of contracts are complements, regardless of the principal’s fallback position. The analysis therefore contrasts earlier results of the literature, and provides a rationale for the application of subjective performance information, as it is frequently incorporated in strategic performance measurement systems.

November 2006

Full text in pdf format:

203.pdf

Limited Liability and the Trade-off between Risk and Incentives

Abstract:

Several empirical findings have challenged the traditional trade-off between risk and incentives. By combining risk aversion and limited liability in a standard principal-agent model the empirical puzzle on the positive relationship between risk and incentives can be explained.

Keywords: limited liability, piece rates, risk aversion, risk-incentives trade-off
JEL classification: D01, D82, J3, M5
April 2007

Full text in pdf format:

201.pdf

Optimal Risk Taking in an Uneven Tournament Game with Risk Averse Players

Abstract:

We analyze the optimal choice of risk in a two-stage tournament game between two players that have different concave utility functions. At the first stage, both players simultaneously choose risk. At the second stage, both observe overall risk and simultaneously decide on effort or investment. The results show that those two effects which mainly determine risk taking — an effort effect and a likelihood effect — are strictly interrelated. This finding sharply contrasts with existing results on risk taking in tournament games with symmetric equilibrium efforts where such linkage can never arise. Hence, previous findings based on symmetry at the effort stage turn out to be nongeneric.

Keywords: asymmetric equilibria, rank-order tournaments, risk taking
JEL classification: C72, J3, L1, M5
April 2007

Full text in pdf format:

200.pdf

Mergers, Litigation and Efficiency

Abstract:

We consider antitrust enforcement within the adversarial model used by the United States. We show that, under the adversarial system, the Antitrust Authority may try to prohibit mergers also in those cases in which litigation is inefficient. Even if market concentration and technological disadvantages lead to a significant welfare reduction after merger, from society’s perspective the agency’s lawsuit may be inefficient. We can show that these inefficiencies may be aggravated if the takeover is hostile.

Keywords: hostile takeover; litigation contest, merger
JEL Classification: D43, K21, L40
December 2006

Full text in pdf format:

185.pdf

Haggling for Rents, Relational Contracts, and the Theory of the Firm

Abstract:

In this paper, a formal rent-seeking theory of the firm is developed. The main idea is that integration (compared to non-integration) facilitates rent-seeking for the integrating party, but makes it harder for the integrated one. In a one-period model, this implies that the rent-seeking contest becomes more uneven and the parties rent-seek less. Here, integration is optimal. In the infinitely-repeated version of the model, it is also possible for the parties to enter a relational contract, under which each promises not to engage in rent-seeking. Such a contract must be self-enforcing, for it cannot be enforced by court. It is shown that integration makes the relational contract less easily sustainable, as, due to its cost advantage, the integrating party gains more from deviating than any party under non-integration. Hence, integration is preferred, if relational contracts are not sustainable, while, otherwise, non-integration may well be preferred. Moreover, it is shown that the model’s predictions are in line with many empirical facts on the choice of ownership structures.

Keywords: Integration, non-integration, relational contracts, rent seeking
JEL Classification: D23, D72, D74, L14, L22
October 2006

Full text in pdf format:

169.pdf

On the "Adverse Selection" of Organizations

Abstract:

According to New Institutional Economics, two or more individuals will found an organization, if it leads to a benefit compared to market allocation. A natural consequence will then be internal rent seeking. We discuss the interrelation between profits, rent seeking and the foundation of organizations. Typically, we expect that highly profitable firms are always founded but it is not clear whether the same is true for firms with less optimistic prospects. We will show that internal rent seeking may lead to a completely reversed result. The impact of internal rent seeking on overall investment and the implications of firm size and competition on the foundation of organizations are also addressed.

Keywords: contests, foundation of organizations, internal rent seeking
JEL Classification: D2, L2, M2
October 2006

Full text in pdf format:

168.pdf

Firm Size, Economic Situation and Influence Activities

Abstract:

This paper discusses the optimal firm size in the presence of influence activities, and the level of individual rent-seeking dependent on the economic situation of the firm. Since firm size has a discouraging effect on the level of individual rent-seeking but also a quantity effect as the number of rent-seekers increases, the interplay of both effects determines whether the employer chooses an inefficiently small or large firm size. In the given setting, a bad economic situation leads to both a higher probability of a substantial loss and a reduction of productivity. The productivity effect and the two other effects together determine the optimal level of individual rent-seeking.

Keywords: economic situation, firm size, influence activities, politicking, rent-seeking
JEL Classification: D2, L2, M2
October 2006

Full text in pdf format:

167.pdf

The Effect of Reputation on Selling Prices in Auctions

Abstract:

In economic approaches it is often argued that reputation considerations influence the behavior of individuals or firms and that reputation influences the outcome of markets. Empirical evidence is rare though. In this contribution we argue that a positive reputation of sellers should have an effect on selling prices. Analyzing auctions of popular DVDs at eBay we, indeed, find support for this hypothesis. Secondary, we unmask the myth that it is promising for eBay sellers to let their auction end at the evening, when many potential buyers may be online.

Keywords: Reputation, eBay feedback system, auction
JEL Classification: D44, D82, K12, L81
May 2006

Full text in pdf format:

114.pdf

On Delegation under Relational Contracts

Abstract:

In this paper, a principal’s decision between delegating two tasks or handling one of the two tasks herself is analyzed. We assume that the principal uses both, formal contracts and informal agreements sustained by the value of future relationships (relational contracts) as incentive device. It is found that the principal is less likely to delegate both tasks in a dynamic setting than in a static one (where formal contracts are the only feasible incentive device), as handling one task herself enables a much wider use of relational contracts.

Keywords: Job design, relational contracts, formal contracts, delegation
JEL Classification: D82, J33, L23, M52, M54
May 2006

Full text in pdf format:

113.pdf

Job Promotion Tournaments and Imperfect Recall

Abstract:

In this paper, a promotion tournament is considered, where, at the beginning of the tournament, it is unknown how long the tournament lasts. Further, the promotion decision is based on the assessments of a supervisor with imperfect recall. In line with psychological research, the supervisor is assumed to either value early or recent impressions more strongly. It is shown that effort may increase or decrease, as the probability of promotion in a certain period gets higher. The single effects determining the sign of the effort change oftentimes depend on how the supervisor processes information.

Keywords: Promotion Tournament, Promotion Probability, Imperfect Recall
JEL Classification: J33, M51, M52
May 2006

Full text in pdf format:

112.pdf

Implicit Contracts: Two Different Approaches

Abstract:

In this paper, I compare two different approaches to model implicit contracting, the infinite-horizon approach typically used in the literature and afinite-horizon approach building on an adverse-selection model. I demonstrate that even the most convincing result of the infinite-horizon approach, namely that implicit contracting is improved, if the discountrate is lowered, does not carry over to the alternative modeling approach. Predictions of the first approach should therefore be handled with care and subject to athorough reinvestigation.

Keywords: Trust, finite horizon, infinite horizon, discounting, implicit contracting
JEL Classification: D82, D83, J33, M52
April 2006

Full text in pdf format:

110.pdf

Optimal Ownership Structures in the Presence of Investment Signals

Abstract:

The property-rights approach to the theory of the firm is extended by introducing distorted signals of the parties.investments. Investment incentives are then given in two ways, by allocating ownership rights and by tying pay to the signal realization. Optimal incentive strength, that is, the weight that a signal is optimally given in a wage contract, depends on two distortions, namely the distortion of the signal from the realized and from the disagreement benefit. Under the optimal ownership structure, the deviations of both investments from their first-best levels are relatively small implying that the relative importance of investment matters. Further, it is shown that most of the Grossman-Hart-Moore results are not robust to an introduction of investment signals.

Keywords: Signal, Property rights, Integration, Distortion
JEL Classification: D2, L2
March 2006

Full text in pdf format:

103.pdf

Performance Pay and Risk Aversion

Abstract:

A main prediction of agency theory is the well known risk-incentive trade-off. Incentive contracts should be found in environments with little uncertainty and for agents with low degrees of risk aversion. There is an ongoing debate in the literature about the first trade-off. Due to lack of data, there has so far been hardly any empirical evidence about the second. Making use of a unique representative data set, we find clear evidence that risk aversion has a highly significant and substantial negative impact on the probability that an employee's pay is performance contingent.

Keywords: Agency theory, GSOEP, Incentives, Pay for performance, Performance appraisal, Risk, Risk aversion
JEL Classification: J33, M52, D80
March 2006

Full text in pdf format:

101.pdf

Contractual Incentive Provision and Commitment in Rent-Seeking Contests

Abstract:

In this paper, we consider a symmetric rent-seeking contest, where employees lobby for a governmental contract on behalf of firms. The only verifiable information is which firm is assigned the contract. We derive the optimal wage contracts of the employees and analyze, whether commitment by determining the wage contract prior to the competitor is profitable. This is indeed the case, i.e. firms prefer to move first in the wage-setting subgame. This complements previous work on rent-seeking contests emphasizing that commitment via rent-seeking expenditures is unprofitable in symmetric contests.

Keywords: Contest, First-Mover Advantage, Commitment, Wage Contract
JEL Classification: D72, M52
March 2006

Full text in pdf format:

100.pdf

Should You Allow Your Agent to Become Your Competitor? On Non-Compete Agreements in Employment Contracts

Abstract:

We discuss a principal-agent model in which the principal has the opportunity to include a non-compete agreement in the employment contract. We show that not imposing such an agreement can be beneficial for the principal as the possibility to leave the firm generates implicit incentives for the agent. The principal prefers to impose such a clause if and only if the value created is sufficiently small relative to the agent's outside option. If the principal can use an option con- tract for retaining the agent, she will never prefer a strict non-compete agreement.

Keywords: fine, incentives, incomplete contracts, non-compete agreements, option contract
JEL Classification: D21, D86, J3, K1, M5
March 2006

Full text in pdf format:

99.pdf

A Note on Sabotage in Collective Tournaments

Abstract:

In this paper a tournament between teams (a collective tournament) is analyzed, where each contestant may spend productive effort in order to increase his team's performance or sabotage the members of the opponent team. It is shown that sabotaging the weaker members of a team always decreases their team's performance more significantly than sabotaging stronger members does. As a consequence, sabotage activities are only directed at a team's weaker members. This finding is quite interesting, as previous results on individual tournaments indicate that oftentimes only the stronger participants should be sabotaged.

Keywords: Collective Tournament, Sabotage, Complementarities
JEL Classification: C72, J33, M52
October 2005

Full text in pdf format:

61.pdf

Rent seeking in sequential group contests

Abstract:

In this paper, a group contest is analyzed, where the groups are allowed to determine their sharing rules either sequentially or simultaneously. It is found that in case the more numerous group determines its sharing rule prior to the smaller group, rent dissipation in the group contest is higher than in an individual contest. However, if the order of moves is endogenized, the smaller group will always act prior to the bigger group. Competition between the groups is in this way weakened and the groups are able to save on expenditures.

Keywords: Group contest, rent seeking, sequential choices, sharing rule
JEL Classification: D 72
May 2005

Full text in pdf format:

47.pdf

Doping in Contest-Like Situations

Abstract:

Individuals who compete in a contest-like situation (for example, in sports, in promotion tournaments, or in an appointment contest) may have an incentive to illegally utilize resources in order to improve their relative positions. We analyze such doping within a tournament game between two heterogeneous players. Three major effects are identified which determine a player’s doping decision — a cost effect, a likelihood effect and a windfall-profit effect. Moreover, we discuss whether the favorite or the underdog is more likely to be doped, the impact of doping on overall performance, the influence of increased heterogeneity on doping, the welfare implications of doping, and possible prevention of doping.

Keywords: contest, doping, drugs, fraud in research, tournament.
JEL Classification: J3, K42, M5
May 2005

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46.pdf

Emotions and the Optimality of Unfair Tournaments

Abstract:

We introduce a concept of emotions that emerge when workers compare their own performance with the performances of co-workers. Assuming heterogeneity among the workers the interplay of emotions and incentives is analyzed within the framework of rank-order tournaments which are frequently used in practice. Tournaments seem to be an appropriate starting point for this concept because the main idea of a tournament is inducing incentives by making workers compare themselves with their opponents. We differentiate between exogenous and endogenous tournament prizes and identify certain conditions under which the employer benefits from emotional workers. In this case, he clearly prefers unfair to fair tournaments. Furthermore, the concept of emotions is used to explain the puzzling findings on the oversupply of effort in experimental tournaments.

Keywords: anger, emotions, pride, tournaments
JEL Classification: J3, M5
May 2005

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45.pdf

Are 18 holes enough for Tiger Woods?

Abstract:

This paper addresses the selection problem in promotion tournaments. I consider a situation with heterogeneous employees and ask whether an employer might be interested in repeating a promotion tournament. On the one hand, this yields a reduction in uncertainty over the employees’ abilities. On the other hand, there are costs if a workplace stays vacant.

Keywords: Promotion tournament, selection, heterogeneous employees, repetition
JEL Classification: D82, M51
May 2005

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44.pdf

Tournaments versus Piece Rates under Limited Liability

Abstract:

Lecture on the first SFB/TR 15 meeting, Gummersbach, July, 18 - 20, 2004

The 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.

Keywords: incentives, limited liability, piece rates, rank-order tournaments
JEL Classification: J31, J33, M5
July 2004

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15.pdf