6 - Relative Performance Evaluation

Question 1

What are the main characteristics of competition between employees? (what is the situation, advantage?)

Answer 1

• employees perform similar tasks -> performance is comparable
• employer fixes prizes before workers compete
• best performing employee gets highest prizes, second best gets second highest prize and so on

Advantage: individual performance does not need to be verifiable!

Question 2

What can competition between employees help firms with?

Answer 2

• incentive provision (in case of moral hazard problems)
• selection purposes (in case of adverse selection problems or symmetric uncertainty about employees’ talents)

Question 3

What are examples of relative performance evaluation?

Answer 3

• job-promotion tournaments
  
  • firms often award a promotion to the best performer in the lower-level job
  • potential conflict between incentives and selection
    
    • e.g., in an R&D organization, the best researcher does not need to be the best manager of the research group - but managers also need good knowledge of the work that subordinates do (firm-specific human capital)! improves the manager’s ability to direct, supervise, and evaluate staff
• forced-distribution systems for performance appraisals
  
  • e.g., specific percentages for each rating helps to reduce the following problems: managers tend to give many employees the same rating; or some are lenient, while others are strict
  • similar concept: grading on a curve
• sales contests
• sharing a fixed bonus pool

Question 4

What is the timing in a typical rank-order tournament-model?

Answer 4

1. employer announces tournament with prizes w₁, w₂
2. workers choose whether to participate in the tournament or not
3. workers choose effort
4. output is observed and prizes are awarded

Question 5

In this output (contribution to firm value) of worker i, what can ε be in real life?

Answer 5

εi can be interpreted as:

• (a) individual measurement error of the supervisor
• (b) individual talent that is unknown to everyone ex ante
• (c) individual productivity shocks

Question 6

What is the prize spread in performance based rank-order tournaments?

Answer 6

Question 7

When is the equilibrium effort e increasing in a rank-order tournament?

Answer 7

• the prize spread △w
• g (0) -> inverse measure of the importance of random influences
• the flatness of the cost function c (·)

Question 8

What is the equilibrium in a rank-order tournament?

Answer 8

the tournament winner is determined by pure luck:

winning probability G (0) = 1/2

Question 9

What is the defining characteristic of the optimal tournament contract?

Answer 9

Even though the workers’ output is not necessarily verifiable, the optimal tournament contract solves the moral hazard problem, i.e., induces the first-best
effort.

Question 10

What is the employer’s maximization problem in a rank-order tournament?

Answer 10

• The employer maximizes the expected net profit per worker
  
  • subject to the incentive constraint (IC) and the participation constraint

Question 11

What is the outcome of the rank-order tournament from the workers’ point of views?

Answer 11

• On average, each worker is just compensated for his effort costs and his forgone outside option ¯u.
• However, ex-post the winner is strictly better off than the loser. ) -> effort incentives

Question 12

How do high random influences change the equilibrium in a rank-order tournament?

Answer 12

The optimal price △w spread gets larger

Question 13

What are advantages of tournaments?

Answer 13

• performance signals do not need to be verifiable (subjective performance evaluation by supervisors)
• ordinal performance information suffices
• filtering common noise
• wage costs are fixed ex ante (piece rates or bonuses: overall wage costs depend on performance)

Question 14

What are disadvantages of tournaments?

Answer 14

• influence activities (e.g. bribing the supervisor)
• sabotage: an employee can increase his expected payment by lowering the performance of others
• collusion (BUT: stable?)
• incentives may be decreased by: external job offers, intermediate information, heterogeneity (BUT: handicaps if leads/types are observable)
• contradicts the cooperative idea of teamwork (BUT: collective tournaments between teams?)

Question 15

What are forced (or stack) ranking systems (also give examples)?

Answer 15

Each business unit’s management team has to review employees’ performance and rank a certain percentage of them as top performers, or as average or poorly performing.

• General Electric CEO Jack Welch (1981-2001) established a “20-70-10” rule:
  
  • employees were ranked into performance categories of the top 20%, middle 70%, and bottom 10% ) last category fired
• Microsoft adapted a similar ranking system in 2006 and abolished it in 2013
  
  • rankings were a key factor in promotions and allocating bonuses
  • employees complained about erratic rankings, power struggles among managers, unhealthy competition among colleagues
• such ranking systems have been much criticized recently

Question 16

What is sabotage in a tournament?

Answer 16

any effort that is intended to reduce the performance of the rival in the tournament, e.g., withholding information, uncooperative behavior, bullying…

• denoted as “negative effort” e_i-

Question 17

What does the article “Empirical evidence from soccer (Garicano and Palacios-Huerta 2005)” tell us about relative performance evaluation model?

Answer 17

incentive change in soccer leagues (tournament between teams):

• historically, soccer teams have been rewarded with 2 points for winning and 1 point for tying
• Since 1994, teams obtain 3 points for winning and 1 point for tying - “to encourage attacking, high-scoring matches”

findings:

• desired, attacking effort (shot attempts on goals, corner kicks) increased (10%)
• sabotage activities (fouls, unsporting behavior punished with yellow cards, more defenders) also increased (12.5%)

in line with the model, net result: number of goals did not change

Question 18

What do Blanes i Vidal and Nossol 2012 find on Tournaments without prizes?

Answer 18

They find a direct effect of informing workers about their position in the productivity and pay distribution!

Situation:

• German wholesale & retail organization, workers for core task = picking up customer orders; collecting products; packing onto trolley; moving to the goods-out area
• salary = fixed base salary + quantity performance component (# orders completed) + quality performance component (- for wrongly dispached goods)
• management agreed to communicate avg wage/h + to rank-order position in the productivity distribution -> first communicated to workers in November, but notified prior to September
• RPI coincided with a sharp increase in productivity, first in September (kickoff period), then in November (revelation period) compared to baseline (July/August)
• effect is positive for most, and negative noone
• only slight transitory decrease in the quality of work done

Question 19

Why would workers behave as Blanes i Vidal and Nossol 2012 find on tournaments without prizes?

Answer 19

relative concerns, i.e., they derive utility directly from outperforming

• theoretical papers show that then all increase their level of effort

career concerns

• workers fear termination of employment if they are low performers / want to increase their chances of promotion
• BUT probability of both termination and promotion is close to zero in this case

certification to outside employers

• workers could use RPI to to prospective employers -> all workers try to improve this signal
• BUT low performers should not provide this information to outside employers ) no reason to increase effort and high performers should more often quit, but this was not observed

Question 20

What does research tell us about tournaments and gender differences?

Answer 20

• studies suggest: men are more motivated by competitive incentives than women, or men are more effective in competitive environments
• Gneezy et al. (2003) let subjects solve computerized mazes: men and women perform equally well under piece rates but men perform better than women under competitive incentives
• Gneezy and Rustichini (2004) show that gender differences are present at a young age:
  
  • in a 40 meter dash, nine-year old boys run much faster in a race than when they run alone
  • girls run as fast as boys when running alone, but do not increase their speed under competition
• gender differences in competition is a possible explanation for the underrepresentation of women in top positions

Question 21

What did Delfgaauw et al. (2013) in their field experiment investigate/find?

Answer 21

sales competition among stores (i.e., tournament between teams) - findings: competition is a powerful motivator, but: employees’ gender matters

the authors designed sales contest among stores:

• performance measure: percentage sales growth compared to the same period last year
• winner prize+second prize
• stores competed in a (relatively homogeneous) pool
• received weekly feedback on sales in all stores
• store managers had to inform employees in their stores about the competition

Results

• tournament has positive effect on sales growth
• effect does not differ between stores with a male manager and female manager, gender composition of teams does not matter
• however: in male-led (female-led) stores, the effect of competition increases in the share of male (female) employees

Question 22

Delfgaauw et al (2013) find: in male-led (female-led) stores, the effect of competition increases in the share of male (female) employees.

What are possible explanations?

Answer 22

effectiveness of communication: managers succeeded in making the competition appeal to employees of their own sex, but failed to do so to employees of the opposite sex

• when working for a manager of opposite sex, employees find duties and responsibilities much more ambiguous
• employees are more likely to establish a relationship based on mutual support, trust, and obligation with same-sex managers (which may facilitate communication)
• participants tend to feel more comfortable supervising a person of the same sex (expecting fewer conflicts and more competence)

avoiding free-rider problems may be easier if a manager and a large part of the store are of the same gender

• a male (female) manager may be better at strengthening the team’s internal cohesion if many team members are male (female)
• but: no evidence for free-riding behavior; bigger stores do not respond less to competition

Question 23

Answer 23

• f(0) describes the probability that the error terms of the competitors are equal to one another.
• These error terms capture idiosyncratic shocks influencing only the respective party.
• The larger f(0), the more like it is that the tournament is decided by effort rather than by luck.