Risk-taking in subjective promotion tournaments

Abstract

This article considers a promotion tournament where the winner is decided by the principal's posterior belief about the agents’ abilities, called a subjective promotion tournament. If the agents can choose the risk of their performance as well as their effort, this article shows that such a subjective tournament can be better than an objective tournament where the winner is decided by the agents’ verifiable performance measures only. This is because the subjective tournament leads to lower uncertainty about the agents’ abilities and a higher level of agents’ effort, thereby providing better sorting and incentive effects.

Keywords:

• promotion tournament
• subjective performance evaluation
• choice of risk

JEL Classification:

• M51
• D82
• J33

Acknowledgements

I would like to thank the participants of the GSPA SD seminar at Seoul National University and 2011 conference on Tournaments, Contests and Relative Performance Evaluation for helpful comments and suggestions.

Notes

¹ To the extent that the choice of risk is observable, one may regard the choice of risk is also objective. Given the lack of clear definition on ‘subjective measure’ in economics, however, we follow the definition of Baker et al. (1994) that a subjective performance measure is an observable but unverifiable performance measure.

² There are also papers on the cases where the agents’ wages are determined by the market's belief about the agents’ ability. (e.g. Holmstrom, 1982; Waldman, 1984) These papers do not analyse the choice of risk.

³ To be more general, I did not assume any specific loss function for the principal. It is sufficient to show that the variance of the agent's expected ability is smaller under the subjective tournament.