Favoring the Winner or Loser in Repeated Contests

Abstract

Should a firm favor a weaker or stronger employee in a contest? Despite a widespread emphasis on rewarding the best employees, managers continue to tolerate and even favor poor performers. Contest theory reveals that evenly matched contests are the most intense, which implies that a contest designer can maximize each player's effort by artificially boosting the underdog's chances. We apply this type of "handicapping" to a two-period repeated contest between employees, in which the only information available about their abilities is their performance in the first period. In this setting, employees are strategic and forward looking, such that they fully anticipate the potential impact of the first-period contest result on the second-period contest and thus adjust their behaviors accordingly. The manager also incorporates these strategic behaviors of employees when determining an optimal handicapping policy. If employees' abilities are sufficiently different, favoring the first-period loser in the second period increases the total effort over both periods. However, if abilities are sufficiently similar, we find the opposite result occurs: total effort increases the most in response to a handicapping strategy of favoring the first-period winner.

Keywords: game theory, contests, handicap, incentives, ratcheting, moral hazard