Efficient Contests

Abstract

In their seminal contribution, Lazear and Rosen (1981) show that wages based upon rank induce the same efficient effort as incentive-based reward schemes. They also show that this equivalence result is not robust toward heterogeneity in worker ability, as long as ability is private information, since it is not possible to structure contests to simultaneously satisfy self-selection constraints and first-best incentives. This paper demonstrates that efficiency can be achieved by a simple modification of the prize scheme in a mixed (heterogenous) contest where contestants learn their type after entry. If contestants know their type before entering the contest, rent extraction becomes an issue. The implications for optimal contest design are explored. Finally, the relationship between effort maximizing contests and profit maximizing contests are discussed.

Keywords: Tournaments, Labor Contracts

JEL Classification: J33