An economic analysis of two player contest with productive effort and sabotage

Rank-order tournament payment schemes are widely adopted by firms and organizations as incentive mechanisms to motivate employees to work hard. However, these schemes also give rise to incentives for sabotage among workers, which will reduce output and thus harm profit-maximizing employers. Liu and Lu (2012) derived in a two-player model the threshold pay dispersion and the equilibrium levels of productive and sabotage effort, based on which they then characterized the optimal pay dispersion that maximizes a firm’s expect profit. The purpose of this study is to offer some insights regarding the usefulness of Liu and Lu’s model by comparing experimental data with the equilibrium predictions of the model. Three treatments were conducted in a between-subject design in the setting of an laboratory experiment simulating a parameterized form of the model. We find that the data largely support the equilibrium predictions of the model. Our findings imply that under the assumptions specified by the model, the optimal pay dispersion derived from the equilibrium predictions can serve as a useful reference for firms in designing contests such as job promotion. An important area for further research is to further generalize the model, e.g. by including more contestants. 1Bachelor of Art