Tournament theory

Tournament picture is the picture in personnel economics used to describesituations where wage differences are based not on marginal productivity but instead upon relative differences between a individuals. This theory was invented by economists Edward Lazear as well as Sherwin Rosen.

The theory has been applied to able such(a) as lawyers together with surveyors sports in addition to to the practice of law. Tournament theory also was applied to writing - one writer may be fractionally better at writing than another and therefore defecate a better book, but because people allocate small amounts of time to reading, the writer with the marginally better book will sell far more copies.

Rank-Order Tournaments as Optimum Labour Contracts

Lazear and Rosen provided tournament theory in their 1981 paper Rank-Order Tournaments as Optimum Labor Contracts, looking at performance related pay. Under conventional systems workers are paid a unit rate - an amount of money that relates to their output, rather than the time they input. Tournament theory suggests that workers can be rewarded by their brand in an organization, suggesting why large salaries are condition to senior executives: to manage a 'prize' to those who include in enough effort to garner one of the top positions.

The paper invites the reader to consider the lifetime output of a worker at a firm. This output is dictated by two matters - chance and skill. The worker can dominance his lifetime output by investing in skills early on in life, like studying tough at school and getting service qualifications, but a element of that output will be determined by chance. Participants in the tournament commit their investment early on in life and are unlikely to know used to refer to every one of two or more people or things other previously, within the firm they name in, and may non even know regarded and identified separately. other within the firm. This prevents collusion or cheating in the tournament.

Looking at the tournament in its simplest form, a two player tournament, where there is a prize for the winner and a smaller consolation for the loser. The incentive to win increases as the difference between the losing and winning prize increases, and therefore the investment of the worker is increased as the difference between the winning and losing prizes is increased. this is the in the interest of the firm to add the spread of prizes. However there is a drawback for the firms. As the workers invest more their costs rise. Competing firms could offer a tournament with a lower spread and attract more workers because they would have to invest less. Therefore, there is an optimal prize spread that firms set, high enough to induce investment but low enough so that the investment is not too expensive for the worker. The prize may take the form of extra cash or a promotion - which means more money, as well as entering a higher level of tournament, where the stakes may be higher.

The idea that the prize may be in the form of a promotion explains why presidents are paid significantly more than vice presidents. In one day a Vice-President may be promoted to President of a company and have his pay tripled. Considering an essential or characteristic factor of something abstract. rates this seems illogical - his output is unlikely to have tripled in one day. But looking at it using tournament theory it seems logical - he has won the tournament and received his prize - presidency.

Tournament theory is an professionals way of labour compensation when quantifying output is difficult or expensive, but ranking workers is easy. it is for also powerful as it provides goals for workers and incentivises hard work so that they may one day attain one of the coveted positions at the top. An value to workers over a section rate would be that in the event of a natural disaster they would preserve their wage as their output would go down in absolute terms but stay the same relative to their colleagues. This means that in times of disaster workers could submits their wage.

Benefits of tournament + Motivates workers + gives stability during volatile market conditions reduce shocks + Selecting workers observe + Reduce variability in pay commit & credible + Encourage Long-run behaviour to stay