Tournaments and Project Selection Under Ambiguity

Abstract

This paper analyzes how ambiguity affects the tournament outcome and the project selection of a multi-business-unit organization. We consider a tournament model where business unit managers compete against each other for a promotion reward but are ambiguous about how relatively well their skills match with the project assigned by a headquarter (HQ). We show that while ambiguity adversely affects business unit managers' effort choices, project risk can partly offset the adverse effect of ambiguity and hence boost effort inputs from business unit managers. This is in sharp contrast with the standard tournament theory, predicting that greater risk reduces contestants' incentives to exert effort. Moreover, the equilibrium prize spread is shown to decrease with ambiguity and increase with project risk. Finally, while greater project risk is unequivocally suboptimal for the organization in the absence of ambiguity, it can be optimal for the organization in the presence of ambiguity. Our results thus highlight an unexplored bright side of risk-taking of organizations and provide novel policy implications for project management under ambiguity. The robustness of our results is also probed from several different perspectives.