Tournament Compensation Systems, Employee Heterogeneity, and Firm Performance

• Published date: 01 May 2013
• Date: 01 May 2013
• DOI: http://doi.org/10.1002/hrm.21535
• Author: Uschi Backes‐Gellner,Kerstin Pull

TOURNAMENT COMPENSATION

SYSTEMS, EMPLOYEE

HETEROGENEITY, AND FIRM

PERFORMANCE

USCHI BACKES-GELLNER AND KERSTIN PULL

Tournament compensation systems are widely used in practice and have

been extensively analyzed theoretically. However, one major problem has

hardly been studied in a company context so far: Although it is theoretically

well understood that tournament compensation systems are only effective

when employees are homogeneous, it has rarely been analyzed what com-

panies can do when they are confronted with employee heterogeneity. In our

article, we derive hypotheses on the performance effects of tournament com-

pensation systems in a context of employee heterogeneity based on tourna-

ment and expectancy theory. Using personnel records from incentive travel

contests, we are able to show that performance is lower in a situation with

employee heterogeneity, but that in heterogeneous tournaments, incentives

may still work for a subgroup of employees whom we term the “threshold

group.” In addition, we also show how companies manage to design the in-

formation disclosure systems necessary to install effective “handicapping”

or “league-building” systems in order to increase the effort-performance

expectancy.

Keywords: reward systems; performance management; pay for perfor-

mance; compensation and benefi ts

Correspondence to: Kerstin Pull, Department of HRM and Organization, School of Business and Economics,

University of Tuebingen, Nauklerstr. 47, D-72074, Tuebingen, Germany, Phone: +49-7071-968778, Fax: +49-7071-

295077, E-mail: kerstin.pull@uni-tuebingen.de.

Human Resource Management, May–June 2013, Vol. 52, No. 3. Pp. 375−398

© 2013 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI: 10.1002/hrm.21535

Introduction

For decades, the link between com-

pensation systems and organizational

performance has attracted attention

in many disciplines, such as manage-

ment, economics, sociology, and—

in particular—strategic human resource

management (SHRM). In this article, we

focus on one special form of performance

compensation: tournament compensation sys-

tems. Tournament compensation systems—

sometimes also called “relative compensa-

tion systems” or “contests”—share one basic

feature: just as in any sports contest, in a

376 HUMAN RESOURCE MANAGEMENT, MAY–JUNE 2013

Human Resource Management DOI: 10.1002/hrm

There is good reason

to believe that

problems associated

with employee

heterogeneity tied

to tournament

compensation

systems will become

even more important

in the future, as

piece rates can

be expected to

lose relevance in

knowledge-intensive

economies.

tournament compensation system, a num-

ber of contestants compete against one an-

other for a given prize (e.g., money, a trophy,

or a medal), and winning the prize depends

on relative, not absolute, performance (Becker &

Huselid, 1992).

While the most prominent organizational

tournaments are promotion systems, as stud-

ied, for example, by Cerdin and le Pargneux

(2009); Derr, Jones, and Toomey (1988); or

Rosenbaum (1984), further examples range

from tournaments as diverse as those for

becoming the “employee of the year” (com-

peting, for example, for a preferred parking

spot), the best mutual fund manager (compet-

ing for the highest year-end bonus; see, e.g.,

Kempf & Ruenzi, 2008), or com-

modity retailer (see, e.g., Casas-

Arce & Martínez-Jerez, 2009) to

broiler production contests (see,

e.g., Knoeber & Thurman, 1994)

or sales contests for salespeople

(striving for a year-end cash bonus

or a luxurious trip). As Casas-Arce

and Martínez-Jerez (2009) con-

clude, tournament compensations

in fact are “pervasive” in today’s

organizational practice.

Yet despite its omnipresence

in the organizational practice,

the management literature only

devoted scant attention to the

analysis of tournament compen-

sation systems (Bothner, Kang, &

Stuart, 2007). While tournament

theory tracing back to the semi-

nal paper by Lazear and Rosen

(1981) provides what would seem

a natural starting point for the

analysis of tournament compen-

sation systems, in this article, we

combine the insights of tourna-

ment theory with those from

expectancy theory (Lawler, 1971;

Vroom, 1964)—one of the leading conceptual

frameworks of work motivation in the man-

agement and organizational psychology liter-

ature (e.g., Pepper, Gore, & Crossman, 2012),

which is now increasingly being recognized

in the economics literature as well (see, e.g.,

Sloof & van Praag, 2010). As we will show,

both theories in fact come to similar conclu-

sions concerning the conditions under which

tournament compensation systems are effec-

tive and under which they are not, and both

approaches ideally supplement each other.

While for the ideal case of homogeneous

contestants Lazear and Rosen (1981) have

shown tournament compensation systems

to induce the very same incentives as a well-

designed system of piece rates (and at the

same time offer some distinct advantages such

as, e.g., lower measurement costs), in our arti-

cle we focus on what happens if employees

are in fact not homogeneous—as is typically

the case in the organizational practice. In the

context of a tournament compensation sys-

tem, employee heterogeneity is equivalent to

contestants differing in their a priori chances

to win the tournament (i.e., some contestants

may have a competitive advantage, whereas

others may have a competitive disadvan-

tage). For example, a contestant in a sales

contest may know he has a much lower a pri-

ori chance to win a prize in the tournament

because the region he serves—unlike other

regions—just witnessed a severe economic

downswing. Another contestant may know

that she has a much higher a priori chance

to win the tournament than her contestants

because her customers are all close by and

easily served while her colleagues lose a lot of

time traveling. As there are many such factors

that cause differences in the a priori chances

to win the tournament, employee heteroge-

neity in tournament compensation systems is

likely to be widespread. Further, there is good

reason to believe that problems associated

with employee heterogeneity tied to tour-

nament compensation systems will become

even more important in the future, as piece

rates can be expected to lose relevance in

knowledge-intensive economies.

From the perspectives of both tournament

theory as well as expectancy theory, it is quite

clear that the incentive effects from tourna-

ment compensation systems—and subse-

quently organizational performance—will be

severely endangered in a situation where con-

testants are heterogeneous. In terms of tour-

nament theory, those employees who know

they have no chance to win the tournament