Incentives and Rank Effects in Managerial Tournaments
Abstract: When firms use relative performance pay in which they rank employees, an employee’s behaviour may respond to the rank they get. What is the relative importance of rank effects compared to monetary incentives? What is the direction of rank effects? Arguably, a bad rank may generate desire to catch up, or it may discourage further effort. In this paper we address these questions by analysing store managers in a large firm where the bonus is determined through a high powered tournament. We study managers’ response to feedback about their rank. In this tournament, the bonus is a step function of rank, and so marginal incentives and rank have a non-monotonic relationship, allowing us to separate the impact of incentives from that of rank on behaviour of managers. First, we find that managers ignore marginal incentives, but respond to rank. Second, their response suggests desire to catch up: when managers get a bad rank on either profit or service, they respond by improving performance. This response is monotonic in rank. Importantly, we show that managers achieve these improvements by making corresponding changes to labour and production, the key input variables directly under their control.