Labor Market Compensation and Economic Behavior: An Experimental Examination of Team Production and Tournaments

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In the standard economic theory of labor markets, employees are compensated based on the value of their individual contributions to output: the relative performance of co-workers does not affect compensation. But corporations are increasingly instituting compensation arrangements that do not reward employees in accordance with the standard theory of labor markets. In one arrangement, often referred to as a tournament, rewards are based upon the relative performance of the participants rather than their absolute performance. In another arrangement, often referred to as team production, teams rather than individuals are responsible for a set of tasks. If firms are able to measure only team output, firms cannot compensate team members in accordance with their individual contributions. Despite widespread incidence of tournaments and team production in labor markets, the economic literature contains relatively little on behavior in tournaments and under team production. These experiments assess behavior, performance, and risk taking under tournaments and team production. Such experiments provide a better understanding of behavior under various compensation schemes as well as a basis for the design of contracts. The research in this proposal provides three separate studies. The first study considers whether tournament participants are overly optimistic regarding success in tournaments (i.e. overestimate their relative performance) and whether this causes too many individuals to enter tournament markets. If too many individuals enter, we may implement public policies to reduce the inefficiencies related to overcrowding. The second study considers whether performance under team production varies based on: i) the number of team members; ii) whether team members have information about the performance of other team members; and iii) whether the firm sets production targets and rewards the team when they exceed the target. A better understanding of team production helps in the design of public policies concerning contractual relations within and between firms. The final study considers whether an irrational desire to avoid losses, referred to as loss aversion, is an important determinant of performance in tournaments and whether this effect diminishes over time. Such information is important in the design of labor contracts. To assess performance and risk taking in tournaments and under team production, we conduct controlled experiments using students at The Pennsylvania State University as subjects. Subjects complete a computer-based numerical forecasting task to measure performance. To simulate labor market decisions, subjects are paid based on the accuracy of their forecasts at the end of each experimental session.