Mixed Tournaments, Common Shocks, and Disincentives: An Experimental Study

Experimental economics is used to investigate two important hypotheses proposed in the economics literature on tournaments. Specifically, we test for a hypothesized “disincentives effect” which can occur in tournaments with mixed ability agents. We also test the well known hypothesis that, when common shocks are an important source of risk, tournaments can filter out this common shock and reduce earnings risk to workers. We find that disincentive effects arose in our tournament experiments, although these effects are not as strong as we predicted in our theoretical model and simulations. We also find that tournaments can be very effective at reducing earnings variation when common shocks are important. Taken together, these results suggest that the benefits of risk reduction from eliminating common shocks might outweigh the disincentive effects arising from mixed tournaments. We also find that the difference in average earnings between low and high ability agents is greater under tournaments than under absolute performance contracts.