Chapter 9: Promotions as motivators
• There are many situations where it is
difficult to provide incentives through piece
rates or bonuses. Æ Promotions might be an
alternative!
• Establish an “internal labor market”
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What is a tournament? (Turnier)
• Promotion can be thought of as a tournament
• Assume a tennis tournament: Federer against
Nadal (plus future rounds)
– Relative performance counts. Winner is the relatively
better player (on this day).
– Monetary rewards are fixed in advance and are
independent of absolute performance.
– Level of effort depends on spread between winner’s
and loser’s prizes.
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Tournament Theory
• Salary structure:
– Level of wages: induces participation in
tournament
– Spread of wages: induces level of effort
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Tournament, 2 workers:
5 years of test phase (engineer), 5 years as project
head later on
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Level of wage structure: participation constraint
Spread of wage structure: incentive condition
Do workers prefer A over B?
Does the employer prefer A over B?
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Advantages of tournaments
• Ease of evaluation: it is easier to observe relative than
absolute performance (e.g. looking at the relative size of a
pile of coal is easier than to weigh it)
• Eliminates effect of external forces that influence all
participants equally. E.g. bad weather, economic downturn
• Neutralizes subjective supervisory evaluation: Some
supervisors are more easy to satisfy than others.
• Eliminates moral hazard on the side of the firm:
number of promotions predetermined
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Importance of „luck“
• „noise“ in statistical terms
– Production or market uncertainty, negative noise: high
effort but still low output
– Measurement errors: output is not perceived correctly
• The higher the noise, the lower the effort of the
workers.
Why?
– The relation between effort and return to effort is weaker
– E.g.: Federer and Nadal play in a hurricane
– E.g.: Superivisors promote according to their daily moods
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Importance of luck
• More luck (noise) reduces effort, which is
bad
• You can counteract by increasing the spread
of the prizes
– Examples: Manager compensation in US/Japan
– Compensation in old industries vs. Start-up or
high-tech firms
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Empirical evidence for tournament
theory
Difficult to get, because output and effort are
difficult to measure by definition
– Ehrenberg, Bonnano (1990): professional golf, higher
average scores when larger spread in prizes
– Drago, Garvey (1997): Australian firms, absenteeism
reduced when promotion leads to larger salary raises
– Laboratory experiments: spread between winner‘s and
loser‘s prize determines effort
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Tournaments and organizational
charts
• Are there any conclusions from tournament theory
for hierarchy levels of the firm?
– „Option“ value of a job: promotion to certain hierarchy level
provides also an option for the next level
– Final round: no more option value, entire prize money
• Reward must be higher
• The more layers in a firm, the larger the difference
between the ability of the people in the top job and in the
bottom job.
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Design of tournaments
• The number of layers between the bottom and top depends
on the heterogeneity of the workers. If workers are
homogeneous, a rather flat structure can be used.
• The length of time between promotions has costs and
benefits:
– Longer time allows better decisions
– Longer time wastes time of good workers who are needed at the
top
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Tournament Theory Implications
• If competing people have different abilities and
know this, effort will be reduced.
– Lower ability people may give up when they have a
small chance of winning.
– Higher ability people may work less hard because they
know that they will win anyway.
• Æ People of one level should have similar
abilities and should be evenly matched with those
against they compete.
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Tournament Theory Implications,
summary
• Tournaments work better if the workers are more homogeneous.
• If workers are heterogeneous, short term rewards are necessary
to maintain incentives for guaranteed winners and losers.
• In job ladders, the option of future promotions also plays a role
in the worker’s performance on a job and her expectations of
promotion.
• At the top of the ladder, there is no option value. Incentives
must come from other sources. This is one explanation of high
CEO salaries and the extent of stock option incentives that are
used.
• Function of top-salaries: not reward for good work, but
aspiration level for lower layers
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Tournament turned extreme:
„Up or out!“
• Tournament: the winner gets promoted to very good job, the
looser has to leave the firm
• Why/when would you induce such a fierce competition?
–
–
–
–
–
Effort has to be very high
You only want to keep the best
Loser has no incentive to work hard anymore
Makes room for young fresh talents with lots of effort
Firm-specific HC not so important
• Examples: US law firms, university tenure decision
• How to induce participation?
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Problem of losers in tournaments
If losers of competition remain in the firm
• Losers may occupy positions, that others below
would like to fill
• Relative failure often seen as absolute failure
• Losers may consider themselves mistreated: Æ loss
of motivation. Maybe install a second-track
competition for different jobs!
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Advantages of promotion from
the inside
• Internal candidates should be favored because of
incentive effects on all workers on the same level.
• If competition is wide open for outside candidates
the probability of being promoted for an internal
one shrinks a lot Æ size of the prize must rise
exorbitantly high to trade this off.
Æ Favor insiders, unless outsiders are far better (or
if you want to avoid collusion)
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Tournament as an incentive contract
• Remember: Incentive contract to avoid the
problem of moral hazard of the worker (shirking)
• But: moral hazard exists also on side of employers
(e.g. incentive via profit share)
• Æ tournaments solve this problem completely
– Prize is fixed in advance, no cheating possible
– Firm must promote one of the candidates
– Firm has good incentive to promote the best candidate
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Disadvantages of tournaments
• Promotion is a discrete incentive – a linear
incentive, if possible, would be better.
• Encourages competition versus team work.
• Gives incentive to do activities that will lead
to promotion at the expense of other
important tasks.
• Workers might collude to keep down average
output.
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Disadvantages of tournaments for
workers
• “Rat race”: both competitors work long hours
to compete with one another for the same prize.
• What dilemma are they facing?
• Possibility of collusion
– To avoid collusion of insiders, you may want to take
an outsider from time to time
– Collusion less likely if the contestants neither know
each other nor the total number of contestants
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Chapter 10: Lobbying and sabotage in
tournaments
• Relative compensation. You win if:
– You „are“ better than the other or
– You „look“ better than the other
• No cooperation with colleagues
• Sabotage of others‘ efforts
• Lobbying to the supervisors
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Hawks and Doves, or:
Personality matters
• Two types of workers: hawks and doves
• Hawks are more aggressive, cooperate less
and may sabotage the others
• Doves are more cooperative
• Should you hire some hawks for your firm?
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Rewards structure and
cooperation
• Mix or match personality types? (Assume at the
end of period, prize will be given to best player)
– Hawk and dove mix
– Hawk and hawk match
– Dove and dove match
• Offer high or low prize?
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Rewards structure and
cooperation
• In mixed couple, reduce wage spread
• If cooperation is important - segregate workers by
personality type! (Match!)
– Advantage: for doves no problem of sabotage, wage spread
(incentive) can be kept high
• Offered prize (wage spread) should be lower for matched
hawks than for matched doves. Prize induces destructive
behavior but also effort! Tradeoff.
• Make couples always with persons who do not interact:
e.g. workers from different branch
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Personality types
• How to observe personality of an
individual?
• Make them sort by personality voluntarily?
– Would be optimal, because then different
incentive levels could be used
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Sorting
• Will hawks and doves self-sort as segregation is
required?
– No!
– Doves would like to work with doves, because they are
hurt by hawks
– Hawks also prefer to work with doves, because it
makes them look better Æ will pretend to be more
cooperative than they really are
• Sorting by firm: Personalities not easily observed!
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Hawks in higher management
• Problem of hawkish behavior particularly
important for higher management. People
there are more hawkish – and necessity to
cooperate is higher!
Æ use other incentive mechanisms
(absolute instead of relative standards)
Æ take CEO from subsidiary, but not from
the immediate subordinates
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Inducing cooperation in
tournament systems
• Generally: workers should have to compete only
against workers with who they do not have to
cooperate (not work on same project, etc.)
• Output based on team output
• Rewards for cooperation/punish sabotage
– Manager observes cooperative behaviour; profit sharing
Æ other worker not in the tournament can observe
coworkers
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Empirical Evidence
• Drago and Garvey (1997): data from 23
Australian firms
– The higher the raises associated with
promotions, the more effort workers put into
the job.
– Workers are less likely to let other workers use
their equipment, tools, or machinery when there
are large raises (based on relative comparisons).
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Relative compensation and hiring
• Which workers will you hire if you have to
compete with them afterwards?
• Example: university professors
• Way out:
• Give potential competitors no say in hiring
• Guaranteed tenure or guaranteed wage
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