The Optimal Allocation of Prizes in Tournaments of Heterogeneous Agents

18 Pages Posted: 21 Nov 2016

See all articles by Loukas Balafoutas

Loukas Balafoutas

University of Innsbruck

E. Glenn Dutcher

Ohio University - Department of Economics

Florian Lindner

affiliation not provided to SSRN

Dmitry Ryvkin

Florida State University

Date Written: January 2017

Abstract

Tournaments are widely used in organizations, explicitly or implicitly, to reward the best‐performing employees, for example, by promotion or bonuses, and/or to penalize the worst‐performing employees, for example, by demotion, withholding bonuses, or unfavorable job assignments. These incentive schemes can be interpreted as various prize allocations based on the employees' relative performance. While the optimal prize allocation in tournaments of symmetric agents is relatively well understood, little is known about the impact of the allocation of prizes on the effectiveness of tournament incentive schemes for heterogeneous agents. We show that while multiple prize allocation rules are equivalent when agents are symmetric in their ability, the equivalence is broken in the presence of heterogeneity. Under a wide range of conditions, loser‐prize tournaments, that is, tournaments that award a low prize to relatively few bottom performers, are optimal for the firm. The reason is that low‐ability agents are discouraged less in such tournaments, as compared to winner‐prize tournaments awarding a high prize to few top performers, and hence can be compensated less to meet their participation constraints.

JEL Classification: M52, J33, J24

Suggested Citation

Balafoutas, Loukas and Dutcher, E. Glenn and Lindner, Florian and Ryvkin, Dmitry, The Optimal Allocation of Prizes in Tournaments of Heterogeneous Agents (January 2017). Economic Inquiry, Vol. 55, Issue 1, pp. 461-478, 2017, Available at SSRN: https://ssrn.com/abstract=2872448 or http://dx.doi.org/10.1111/ecin.12380

Loukas Balafoutas (Contact Author)

University of Innsbruck ( email )

Universit├Ątsstra├če 15
Innsbruck, Innsbruck 6020
Austria

E. Glenn Dutcher

Ohio University - Department of Economics ( email )

Athens, OH 45701-2979
United States

Florian Lindner

affiliation not provided to SSRN

Dmitry Ryvkin

Florida State University ( email )

Tallahassee, FL 30306-2180
United States

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