A Theoretical and Experimental Investigation of Efficiency, Equity, and Uncertainty in Tournaments

This dissertation consists of three essays centered around labor incentives that arise in relative compensation contracts. Chapter 1 poses the question: if devotion to a core competence were truly optimal, why would firms do otherwise? We argue that the behavior of drifting from the core may be motivated by the competitive incentives faced by managers who seek to rise within a firm. We find competition creates an incentive for a manager to look for less correlated opportunities that pull the firm in a new direction. In a symmetric equilibrium all managers behave this way, leading to lower expected output for the firm. A ?stick? that punishes the lowest performing manager in conjunction with a prize to the top performer can deter such behavior. Chapter 2 investigates how common shocks affect the behavior of heterogeneous agents in contracts designed to achieve both equity and efficiency. We show that when a procedurally fair and efficient tournament is desirable and compensates for heterogeneity, common shocks can bias the probability of winning of the agents. Also, the principal is found to have a commitment problem, favoring low risk agents to win, when fair and efficient tournaments are held between agents with different uncertainty distributions. Chapter 3 uses an experiment to examine issues of fairness and efficiency in rank-order tournaments with agents heterogeneous in abilities and random shock distributions. To study these issues, we observe agent effort, contract choice, and role choice from participating in three contracts that vary in perceptions of equal opportunity: equal access, equal expected earnings, and equal changes of winning. The primary result is that equal pay in the form of equal expected outcomes promotes efficiency and greater perceptions of fairness than does equal access to common contracts