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Rank-Order Tournaments as Optimum Labor Contracts

Edward P. Lazear^1,2; Sherwin Rosen³

¹ National Bureau of Economic Research · ² IZA - Institute of Labor Economics · ³ University of Chicago

This paper analyzes compensation schemes which pay according to an individual's ordinal rank in an organization rather than his output level. When workers are risk neutral, it is shown that wages based upon rank induce the same efficient allocation of resources as an incentive reward scheme based on individual output levels. Under some circumstances, risk-averse workers actually prefer to be paid on the basis of rank. In addition, if workers are heterogeneous inability, low-quality workers attempt to contaminate high-quality firms, resulting in adverse selection. However, if ability is known in advance, a competitive handicapping structure exists which allows all workers to compete efficiently in the same organization.

DOI

10.1086/261010

Volume

89 (5)

Pages

841-864

Language

en

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