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  • Tournaments, Individualized Contracts and Career Concerns

November 2005

IZA DP No. 1841: Tournaments, Individualized Contracts and Career Concerns

Alexander K. Koch, Eloic Peyrache

revised and extended version published as 'Aligning Ambition and Incentives' in: Journal of Law, Economics, and Organization , 2011, 27(1).

Young professionals typically do not enter into life-long employment relations with a single firm. Therefore, future employers can learn about individuals' abilities from the observable facts regarding earlier work relations. We show that these informational spill-overs have profound implications for organizational design and the resulting optimal incentive contracts. Through the organizational choice and the contracts that it offers individuals, a firm can strategically manipulate the flow of information to future employers and sharpen incentives. Using a simple moral hazard model, we demonstrate that relative performance contracts, such as rank-order tournaments, can be optimal even though the extant explanations for the optimality of such compensation schemes are absent. The paper discusses the distortions that can arise and explores the robustness of the result.

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Keywords

  • asymmetric learning
  • relative performance contracts
  • tournaments
  • reputation

JEL Codes

  • D82
  • J33
  • L14
  • M52
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