Endowment Origin, Demographic Effects, and Individual Preferences in Contests

• Author: Roman M. Sheremeta,Curtis R. Price
• Date: 01 September 2015
• Published date: 01 September 2015
• DOI: http://doi.org/10.1111/jems.12108

Endowment Origin, Demographic Effects, and

Individual Preferences in Contests

CURTIS R. PRICE

Department of Economics & Marketing

Romain College of Business

University of Southern Indiana

8600 University Blvd.

Evansville, IN 47712

crprice1@usi.edu

ROMAN M. SHEREMETA

Weatherhead School of Management

Case Western Reserve University

11119 Bellflower Road

Cleveland, OH 44106

rms246@case.edu

In modern firms the use of contests as an incentive device is ubiquitous. Nonetheless, experimental

research shows that in the laboratory subjects routinely make suboptimal decisions in contests

even to the extent of making negative returns. The purpose of this study is to investigate how

earning the endowment, demographic differences, and individual preferences impact behavior

in contests. To this end, we conduct a laboratory experiment in which subjects expend costly

resources (bids) to attain an award (prize). In line with other laboratory studies of contests, our

results show that subjects overbid relative to theoretical predictions and incur substantial losses

as a result. Making subjects earn their initial resource endowments mitigates overbidding and

thus increases efficiency. Overbidding is linked to gender, with women bidding higher than men

and having lower average earnings. Other demographic information, such as religiosity, and

individual preferences, such as preferences toward winning and risk, also influence behavior in

contests.

1. Introduction

The use of contests as an incentive device has garnered much attention by researchers.

Certainly, competition as an incentive device often has advantages over other noncom-

petitive incentive schemes (Lazear and Rosen, 1981; Nalebuff and Stiglitz, 1983). Even

so, these advantages may be eliminated if the agents in these situations make systemat-

ically inefficient choices. Since the original studies of Bull et al. (1987) and Millner and

Pratt (1989), a number of laboratory studies have shown that subjects make significantly

higher bids in contests than predicted; for a comprehensive review see Dechenaux et al.

We thank two anonymous referees and a coeditor for valuable suggestions, as well as Tim Cason, James

Choi, Larry Iannaccone, Will Masters, David Ong, WafaOrman, Jared Rubin, seminar participants at Purdue

University, Chapman University, University of Southern Indiana and participants at the Economic Science

Association conference in Tucson. We graciously acknowledge the Vernon Smith Experimental Economics

Laboratory at Purdue University for facilitating the collection of the data and the University of Southern

Indiana for financial support of this research. Our data and z-Tree codes are available upon request. Any

remaining errors are ours.

C2015 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume24, Number 3, Fall 2015, 597–619

598 Journal of Economics & Management Strategy

(2015). In some instances, the magnitude of overbidding is so high that subjects make

negative expected payoffs.

Contests have been used to investigate effort choices of workers (Lazear and Rosen,

1981) and the allocation of resources to achieve a goal such as research and development

funding (Harris and Vickers, 1985, 1987). To motivate this study we focus on the allo-

cation of resources but our results could also be applied to the context of effort choices

and, as such, add to a quickly growing literature about the impact of competition and

choices (Niederle and Vesterlund, 2007; Dohmen and Falk, 2011). We find the alloca-

tion of resources question to be of particular importance because the fact that agents in

these instances make decisions which generate negative payoffs is of paramount con-

cern to the organizations which may employ contests as an incentive device. In turn,

this inefficient use of resources constitutes a problem of moral hazard as managers of

organizations must determine the best way to endow subordinates with resources used

to perform productive tasks (e.g., research and development). If the way that managers

endow subordinates with resources is a causal factor in the misuse of resources then it

would be prudent for the manager to provide resources in a circumspect way. As such,

the results of this research should be of interest to both management researchers and

management practitioners alike.

In this study, we examine several variables which may have an impact on the

use of costly resources in contests. These are endowment differences, demographic

differences and differences of individual preferences. To investigate these variables we

design a laboratory experiment which allows us to systematically vary the origin of the

endowment between a windfall endowment and an earned endowment before subjects

participate in a lottery contest. We also capture demographic data on decision makers,

such as gender, religiosity, major, economics classes and age, as well as individual

preferences, such preferences toward winning and risk.

Our experiment results indicate that when subjects earn their endowments, bidding

decreases by 11–16% compared to the windfall endowments. Demographic character-

istics, such as gender and religiosity, and individual preferences, such as preferences

toward winning and risk, are significant predictors of subjects’ bidding behavior in con-

tests. Wefind that subjects who indicate higher utility for winning or higher tolerance for

risk make higher bids in contests. Surprisingly, demographic effects are even stronger

than treatment effects, with women making 25% higher bids and more religious subjects

making 26% lower bids. Furthermore, when including these demographic variables in

our analysis, we find that a large portion of the treatment effects are subsumed by the

demographic effects.

This study adds to the understanding of two phenomena in the literature: (1) over-

bidding relative to the standard Nash equilibrium prediction and (2) heterogeneous

behavior of contestants (Sheremeta, 2013; Dechenaux et al., 2015). We find that signifi-

cant portion of overbidding can be explained by the fact that subjects receive windfall

endowments (house money) before participating in contests. Additionally, we find that

demographic differences, such as gender and religiosity, as well as heterogeneous pref-

erences, such as preferences toward winning and risk, have a significant impact on

bidding and thus can explain heterogeneous behavior of contestants. Also, our paper

contributes to a large literature on gender differences (Croson and Gneezy, 2009) and

the growing literature on religion and economic behavior (Hoffmann, 2013).

The rest of the paper is organized as follows: Section 2 provides a brief literature

review. Section 3 details the experimental design and procedures. Section 4 reports

the results of the experiment. Lastly, Section 5 concludes and suggests directions for

future rese arch.