[1] This theory was invented by economists Edward Lazear and Sherwin Rosen.
Tournament theory also was applied to writing - one writer may be fractionally better at writing than another (and therefore have 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.
Under conventional systems workers are paid a piece 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 rank in an organization, suggesting why large salaries are given to senior executives: to provide a 'prize' to those who put 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.
Competing firms could offer a tournament with a lower spread and attract more workers because they would have to invest less.
In one day a Vice-President may be promoted to President of a company and have his pay tripled.
Tournament theory is an efficient way of labour compensation when quantifying output is difficult or expensive, but ranking workers is easy.
It is also effective 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 advantage to workers over a piece 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.
[2] Benefits of tournament (+) Motivates workers (+) Offers stability during volatile market conditions (reduce shocks) (+) Selecting workers (observe) (+) Reduce variability in pay (commit & credible) (+) Encourage Long-run behaviour to stay There are two foundational predictions of tournament theory.
These predictions can be illustrated by examining a simple two-player contest with identical risk-neutral actors.
The first is that an actor's level of effort increases with the spread between the winning and losing prize.
[5] These two testable predictions of tournament theory have been supported by empirical research over the years, especially in the fields of labour economics[6] and sports.
[8] The distribution of effort for one tournament experiment found that almost 80% of participants exert higher than anticipated levels of efforts, thus suggesting that tournaments provides strong competition incentives.
Studies show that participants in tournaments value winning itself and placing highly on relative rankings.
[10] One experiment found that more than 40% of individuals were willing to exert positive effort with a monetary incentive of $0.
The theoretical prediction in the literature is that higher-skilled individuals would be sorted into jobs that offer higher potential returns.
Incentive based tournaments are organised in such a way that some winners are created at the expense of many losers.
[14] Thus, by design there are likely to be high inequalities in payoffs in the workplace under a tournament structure.
Field studies have shown that women are less likely to enter tournaments than men and also do not perform as well.
This means that participants in a tournament structured workplace would be less likely to help each other and are discouraged from knowledge sharing more so than in other incentive schemes.
[17] Through such increased opportunistic and selfish behavior, firms with tournament structures and large inequalities in payoffs may harm their customer relationships.
[18] Further, tournaments may also encourage unethical behaviour in participants such as cheating or collusion in competitive sports or plagiarism in the academic field.