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On The Efficiency Of Tournament Incentives…And The Road Back To Popularity For The SNL Cold Open…

March 10th, 2009 · 5 Comments
Incentives

I’m beginning to think that I watch too much television. (In fact, it’s on in the background right now.) At least this time I paid more attention to the show I was watching than the commercials, since I was beginning to feel like the little kid who gets the cool new toy for her birthday and ends up playing with the box it came in instead. Anyway…the latest cold open on SNL was pretty entertaining to an econ nerd like me (text below the video):

From Treasury Secretary Tim Geithner:

“Earlier today, I proposed that the federal treasury set aside 420 billion dollars…this 420 billion dollars will be placed in a special fund and will go to the first individual who comes up with a workable plan to solve the banking crisis. If you have such a plan, or know of someone who does, you can call the number on the screen below to claim this reward (1-800-IDEAS?)…”

See, *I* think it’s funny because, while the SNL people were presumably just trying to get some laughs, they actually stumbled upon a bit of truth in their parody. Traditionally, when there is work to be done, a firm will try to figure out who would be the best person for the job (of those willing to work for the wage offered), hire that person and have him or her produce output. However, it’s somewhat difficult to know at the outset who will produce the best output. A number of firms recently have turned the traditional model on its head and have started offering contests where potential employees all produce output and then the best product is chosen and the creator of that product is compensated. (I was told that a friend of mine got cover art for his book in that way, and I think the system worked out quite well. The book is pretty interesting too- see here if you are curious. Also, JZ- feel free to correct me if I am mistaken.)

This is actually just an extreme form of a tournament incentive- with traditional tournament compensation, workers are paid according to their rank, and in this case the system is just modified such that everyone but the top-ranked worker gets nothing. Economists have shown that rank-order tournament compensation systems can provide efficient incentives for workers- more on that later, but do a Google search for Ed Lazear if you are feeling impatient.

Obviously, the payout to the winner of one of these contests would have to be higher than it would be in a traditional employment system- why would anyone produce output with the risk of not getting compensated for it if the payout to the winner didn’t make it worth it? (You would likely also get less risk-averse than average individuals participating in these contests.) That said, the organization running the tournament should find it worthwhile to offer a high payout to the winner (or at least higher compensation than it would give a traditional employee), since it gets a better product if it gets to choose the best of the available options once the output is produced.

There are some potential pitfalls to consider here. For example, what if all of the best producers are too risk-averse to enter the contest? This seems unlikely, since it would indicate a severe lack of self-awareness on the part of those workers…better workers should think that they have a higher chance of winning the contest and thus be more willing to compete. On that note, the tournament incentive could cause a bunch of overconfident yet untalented people to enter the contest, in which case the firm would have to sift through a bunch of mediocre submissions to find the good stuff. Also, there is evidence that men and women respond to tournament incentives differently…stay tuned.

Tags: Incentives

5 responses so far ↓

  • 1 econgirl // Mar 12, 2009 at 7:55 pm

    As a follow up, the link to the details of JZ’s book cover contest can be found here (just scroll past the weird cat thing):

    http://www.worth1000.com/contest.asp?contest_id=16326&display=

    What I find most interesting is that the payouts to the winners are a lot lower than I thought they would be.

  • 2 Roland Martinez // Aug 6, 2011 at 2:26 am

    But how to you compensate the employees that choose which entry is best? How do you know they have the best judgement? For example on the book cover, what makes an author particularly qualified to make a marketing decision?

    Whee round and round we go with incentives, agency problems and compensation structures.

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