Tournament Rewards and Risk Taking

Abstract

This article considers a Lazear‐Rosen tournament model where agents can influence both the spread of their output distribution (risk taking) and its mean. The unique equilibrium induces excessive risk taking and a low level of effort. By modifying the tournament to give the highest prize to the agent with the “most moderate” output, a low level of risk taking and high level of effort can be sustained as an equilibrium. The first result can be useful to understand the Relative Performance Evaluation Puzzle of executive compensation, and the second result can be useful to understand puzzling workplace norms promoting mediocrity.