What are the main characteristics of competition between employees? (what is the situation, advantage?)
- employees perform similar tasks -> performance is comparable
- employer fixes prizes before workers compete
- best performing employee gets highest prizes, second best gets second highest prize and so on
Advantage: individual performance does not need to be verifiable!
What can competition between employees help firms with?
- incentive provision (in case of moral hazard problems)
- selection purposes (in case of adverse selection problems or symmetric uncertainty about employees’ talents)
What are examples of relative performance evaluation?
- job-promotion tournaments
- firms often award a promotion to the best performer in the lower-level job
- potential conflict between incentives and selection
- e.g., in an R&D organization, the best researcher does not need to be the best manager of the research group - but managers also need good knowledge of the work that subordinates do (firm-specific human capital)! improves the manager’s ability to direct, supervise, and evaluate staff
- forced-distribution systems for performance appraisals
- e.g., specific percentages for each rating helps to reduce the following problems: managers tend to give many employees the same rating; or some are lenient, while others are strict
- similar concept: grading on a curve
- sales contests
- sharing a fixed bonus pool
What is the timing in a typical rank-order tournament-model?
- employer announces tournament with prizes w1, w2
- workers choose whether to participate in the tournament or not
- workers choose effort
- output is observed and prizes are awarded
In this output (contribution to firm value) of worker i, what can ε be in real life?
εi can be interpreted as:
- (a) individual measurement error of the supervisor
- (b) individual talent that is unknown to everyone ex ante
- (c) individual productivity shocks
What is the prize spread in performance based rank-order tournaments?
When is the equilibrium effort e increasing in a rank-order tournament?
- the prize spread △w
- g (0) -> inverse measure of the importance of random influences
- the flatness of the cost function c (·)
What is the equilibrium in a rank-order tournament?
the tournament winner is determined by pure luck:
winning probability G (0) = 1/2
What is the defining characteristic of the optimal tournament contract?
Even though the workers’ output is not necessarily verifiable, the optimal tournament contract solves the moral hazard problem, i.e., induces the first-best
effort.
What is the employer’s maximization problem in a rank-order tournament?
- The employer maximizes the expected net profit per worker
- subject to the incentive constraint (IC) and the participation constraint
What is the outcome of the rank-order tournament from the workers’ point of views?
- On average, each worker is just compensated for his effort costs and his forgone outside option ¯u.
- However, ex-post the winner is strictly better off than the loser. ) -> effort incentives
How do high random influences change the equilibrium in a rank-order tournament?
The optimal price △w spread gets larger
What are advantages of tournaments?
- performance signals do not need to be verifiable (subjective performance evaluation by supervisors)
- ordinal performance information suffices
- filtering common noise
- wage costs are fixed ex ante (piece rates or bonuses: overall wage costs depend on performance)
What are disadvantages of tournaments?
- influence activities (e.g. bribing the supervisor)
- sabotage: an employee can increase his expected payment by lowering the performance of others
- collusion (BUT: stable?)
- incentives may be decreased by: external job offers, intermediate information, heterogeneity (BUT: handicaps if leads/types are observable)
- contradicts the cooperative idea of teamwork (BUT: collective tournaments between teams?)
What are forced (or stack) ranking systems (also give examples)?
Each business unit’s management team has to review employees’ performance and rank a certain percentage of them as top performers, or as average or poorly performing.
- General Electric CEO Jack Welch (1981-2001) established a “20-70-10” rule:
- employees were ranked into performance categories of the top 20%, middle 70%, and bottom 10% ) last category fired
- Microsoft adapted a similar ranking system in 2006 and abolished it in 2013
- rankings were a key factor in promotions and allocating bonuses
- employees complained about erratic rankings, power struggles among managers, unhealthy competition among colleagues
- such ranking systems have been much criticized recently
What is sabotage in a tournament?
any effort that is intended to reduce the performance of the rival in the tournament, e.g., withholding information, uncooperative behavior, bullying…
- denoted as “negative effort” ei-
What does the article “Empirical evidence from soccer (Garicano and Palacios-Huerta 2005)” tell us about relative performance evaluation model?
incentive change in soccer leagues (tournament between teams):
- historically, soccer teams have been rewarded with 2 points for winning and 1 point for tying
- Since 1994, teams obtain 3 points for winning and 1 point for tying - “to encourage attacking, high-scoring matches”
findings:
- desired, attacking effort (shot attempts on goals, corner kicks) increased (10%)
- sabotage activities (fouls, unsporting behavior punished with yellow cards, more defenders) also increased (12.5%)
in line with the model, net result: number of goals did not change
What do Blanes i Vidal and Nossol 2012 find on Tournaments without prizes?
They find a direct effect of informing workers about their position in the productivity and pay distribution!
Situation:
- German wholesale & retail organization, workers for core task = picking up customer orders; collecting products; packing onto trolley; moving to the goods-out area
- salary = fixed base salary + quantity performance component (# orders completed) + quality performance component (- for wrongly dispached goods)
- management agreed to communicate avg wage/h + to rank-order position in the productivity distribution -> first communicated to workers in November, but notified prior to September
- RPI coincided with a sharp increase in productivity, first in September (kickoff period), then in November (revelation period) compared to baseline (July/August)
- effect is positive for most, and negative noone
- only slight transitory decrease in the quality of work done
Why would workers behave as Blanes i Vidal and Nossol 2012 find on tournaments without prizes?
relative concerns, i.e., they derive utility directly from outperforming
- theoretical papers show that then all increase their level of effort
career concerns
- workers fear termination of employment if they are low performers / want to increase their chances of promotion
- BUT probability of both termination and promotion is close to zero in this case
certification to outside employers
- workers could use RPI to to prospective employers -> all workers try to improve this signal
- BUT low performers should not provide this information to outside employers ) no reason to increase effort and high performers should more often quit, but this was not observed
What does research tell us about tournaments and gender differences?
- studies suggest: men are more motivated by competitive incentives than women, or men are more effective in competitive environments
- Gneezy et al. (2003) let subjects solve computerized mazes: men and women perform equally well under piece rates but men perform better than women under competitive incentives
- Gneezy and Rustichini (2004) show that gender differences are present at a young age:
- in a 40 meter dash, nine-year old boys run much faster in a race than when they run alone
- girls run as fast as boys when running alone, but do not increase their speed under competition
- gender differences in competition is a possible explanation for the underrepresentation of women in top positions
What did Delfgaauw et al. (2013) in their field experiment investigate/find?
sales competition among stores (i.e., tournament between teams) - findings: competition is a powerful motivator, but: employees’ gender matters
the authors designed sales contest among stores:
- performance measure: percentage sales growth compared to the same period last year
- winner prize+second prize
- stores competed in a (relatively homogeneous) pool
- received weekly feedback on sales in all stores
- store managers had to inform employees in their stores about the competition
Results
- tournament has positive effect on sales growth
- effect does not differ between stores with a male manager and female manager, gender composition of teams does not matter
- however: in male-led (female-led) stores, the effect of competition increases in the share of male (female) employees
Delfgaauw et al (2013) find: in male-led (female-led) stores, the effect of competition increases in the share of male (female) employees.
What are possible explanations?
effectiveness of communication: managers succeeded in making the competition appeal to employees of their own sex, but failed to do so to employees of the opposite sex
- when working for a manager of opposite sex, employees find duties and responsibilities much more ambiguous
- employees are more likely to establish a relationship based on mutual support, trust, and obligation with same-sex managers (which may facilitate communication)
- participants tend to feel more comfortable supervising a person of the same sex (expecting fewer conflicts and more competence)
avoiding free-rider problems may be easier if a manager and a large part of the store are of the same gender
- a male (female) manager may be better at strengthening the team’s internal cohesion if many team members are male (female)
- but: no evidence for free-riding behavior; bigger stores do not respond less to competition
- f(0) describes the probability that the error terms of the competitors are equal to one another.
- These error terms capture idiosyncratic shocks influencing only the respective party.
- The larger f(0), the more like it is that the tournament is decided by effort rather than by luck.
