Publication Type

Journal Article

Version

publishedVersion

Publication Date

5-2013

Abstract

A highly acclaimed result is that tournaments are superior to piece rates when the agents are risk averse and their production activities are subject to a relatively large common shock. The reason is that tournaments allow the principal to trade insurance for lower income to the agents. Our analysis shows that this celebrated result does not carry over to the case when a limited liability (bankruptcy) constraint limits the payments the principal can make, provided that the liquidation value of the firm is sufficiently small. This finding has important implications for the vast number of limited liability firms. Even though limited liability becomes an issue for different ranges of liquidation values under the two schemes, tournaments are still superior when the liquidation value of the firm is intermediate or large, even though the limited liability constraint is still binding for intermediate values. Surprisingly, uncertainty in the price of output strengthens the need for tournaments by expanding the range of liquidation values over which tournaments are dominant, because price uncertainty introduces additional bankruptcy risk. These findings provide insight into policy implications in the contracting out of services by state and local governments, in procurement, in rent-seeking contests and in tournaments used by HMOs. (C) 2012 Elsevier B.V. All rights reserved.

Keywords

Tournaments, Contests, Piece rates

Discipline

Economics | Economic Theory

Research Areas

Economic Theory

Publication

International Journal of Industrial Organization

Volume

31

Issue

3

First Page

223

Last Page

237

ISSN

0167-7187

Identifier

10.1016/j.ijindorg.2012.11.007

Publisher

Elsevier

Copyright Owner and License

Authors

Additional URL

https://doi.org/10.1016/j.ijindorg.2012.11.007

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