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Tournament theory

Tim Harford on why office life is really a tournament
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Office life may not be a game, but it is a 'tournament', a word economists use to describe situations where winners walk off with the rewards. A race to develop a patent for a new drug is a tournament. Fund managers scoop the lion’s share of customers by beating the market, rather than delivering objectively excellent returns. And many offices promote or pay bonuses to those who outperform peers. Sometimes the competition is subtle and implicit, at other times brashly celebrated — but it’s all a tournament.

Tournament pay makes sense from an employer's point of view, and goes some way to explaining the frustrations of office life. (Key predictions of tournament theory: when there is more luck involved, bonuses have to be bigger to have a motivational effect, bosses need to be paid vast and largely unearned bonuses to motivate their underlings and, when the incentives are sharp enough, workers will deliberately sabotage each other.) But one interesting question is hard to answer: how does tournament pay affect the risks that people take? This is a tough question because it is generally hard to observe risk-taking directly.

Economists Christos Genakos of Cambridge and Mario Pagliero of Turin have found an exception: professional weightlifting contests. Because weightlifters announce in advance the weight they will attempt, it’s possible to observe people taking risks. With 17 years of data, the researchers were also able to track individual weightlifters across time and see whether they behaved differently in different situations.

They concluded that prestigious tournaments encourage more risk- taking. They also concluded that people take more risks when close to but outside a medal position. Tournament leaders play it safe, as do competitors completely out of contention. Those in sixth place are most likely to go for broke.

This finding is a lot more potent given the context of a banking crisis blamed in part on a bonus culture that encouraged bankers to take too many risks. While popular anger is focused on the sheer scale of bankers’ bonuses, many economists are concerned that naïvely designed bonuses may have contributed to the crisis.

As Genakos and Pagliero remark, “Tournaments can be too successful in encouraging risk-taking… while this may be ideal in sport… it may not be so desirable in firms.” Ouch.

Tim Harford, 'Undercover Economist' at the Financial Times, is author of The Logic of Life

Tim Harford

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