Relative Performance Compensation, Contests, and Dynamic Incentives

Abstract

Contests (or tournaments) are pervasive in organizations. They help performance evaluation by eliminating common shocks affecting agents' performance. However, tournaments are less effective when participants have heterogeneous ability because participants may conclude that the ability gap is too large to be overcome by their effort. Our theoretical analysis shows that a similar loss of motivation arises when tournaments take place over multiple periods because interim performance acts in a way that is similar to heterogeneous ability. Analyzing the sales contests organized by a commodities company, we document that winning participants decrease their effort as their lead extends, whereas the effort of trailing participants fades only when the gap to a winning position is very large. We also show that, on average, when contests are introduced they induce a higher level of effort among participants, although the incentives weaken as the number of participants increases. Finally, we demonstrate that although retailers respond to the multiple performance dimensions of the incentive program in part by shifting effort toward sales of more expensive products, they channel most of the increased effort toward reaching more customers.tournaments, relative performance compensation, dynamic incentives, multitasking

Performance responses to competition across skill levels in rank‐order tournaments: field evidence and implications for tournament design

“…For example, Garcia and Tor () show that average test scores decreased with the number of test takers and that average test times decreased when subjects believed they were taking the test with fewer other participants. Closer to questions of heterogeneity, Casas‐Arce and Martínez‐Jerez () find that in a dynamic multiperiod contest, leaders decrease their effort when their lead in a given period extends. Boudreau, Lacetera, and Lakhani () study an order‐statistic mechanism whereby adding competitors increases the observed range and dispersion of solutions through an increase in the number of “draws.” That research shows that this effect increases with increased problem‐solution uncertainty.…”

“…Given the widespread use of tournaments in the economy and potentially different objectives of tournament sponsors, these policies provide useful “levers” for tournament designers. For example, sales managers may run contests with the goal of maximizing total sales (Casas‐Arce and Martínez‐Jerez, ), whereas those managing a research and development tournament may only be concerned with attracting the best possible solution (Fullerton and McAfee, ).…”

When beauty helps and when it hurts: An organizational context model of attractiveness discrimination in selection decisions

“…Organizations create competitive interdependence by rewarding relative performance, so that the superior performance of an employee produces rewards for that individual but leaves other employees worse off. Such reward systems may be used to stimulate performance in a number of domains of organizational activity (Becker & Huselid, 1992;Casas-Arce & Martínez-Jerez, 2009). For example, employees working in sales may receive bonuses such that only the highest performer or a few employees with the highest performance receive a bonus.…”

Using Tournaments to Reduce Agency Problems: The Case of Franchising

“…We thank an anonymous reviewer for raising this point. Martínez-Jerez, 2009;Harbring & Irlenbusch, 2008;Kalra & Mengze, 2001). To continue the sports metaphor, the interorganizational analogy to the tournament may be the "tryout" (Lazear & Rosen, 1981).…”