Business Life: Olympian standards

2nd February, 2010

First published in Business Life, May 2009

Office life may not be a game, but it is a tournament. Economists use the word “tournament” to describe situations where the winner – or a few winners – walk off with the rewards. A race to develop a patent for a new drug is a tournament. Fund managers scoop the lion’s share of customers by beating the market, rather than delivering objectively excellent returns.  And many offices promote or pay bonuses to those who outperform their peers. Sometimes the competition is subtle and implicit, at other times brashly celebrated – but it’s all a tournament.
Tournament pay makes sense from the point of view of employers, and goes some way to explaining the frustrations of office life. (Some key predictions of tournament theory: when there is more luck involved, bonuses have to be bigger to have a motivational effect; bosses need to be paid vast and largely unearned bonuses to motivate their underlings; and when the incentives are sharp enough, workers will deliberately sabotage each other. Is it all starting to make sense?) But one interesting question is hard to answer: how does tournament pay affect the risks that people take? This is a tough question because it is generally hard to observe risk-taking directly.
Two economists, Christos Genakos of Cambridge and Mario Pagliero of Turin, have discovered an exception: professional weight-lifting contests. Because weightlifters announce in advance the weight they will attempt, it’s possible to observe people taking risks by lifting heavier weights. With data from 17 years of competition, the researchers are also able to track individual weightlifters across time and see whether they behave differently in different situations.
They conclude that more prestigious tournaments, such as the Olympic games, encourage more risk-taking. They also conclude that people take more risks when close to but outside a medal position. Tournament leaders play it safe, and so do those completely out of contention. Competitors lying in sixth place are most likely to go for broke.
This finding is a lot more potent given the context of a banking crisis which is blamed in part on a bonus culture that encouraged bankers to take too many risks. While popular anger is focused on the sheer scale of bankers’ bonuses, many economists are concerned that naïvely-designed bonuses may have contributed to the crisis.
As Genakos and Pagliero comment, “tournaments can be too successful in encouraging risk-taking… while this may be ideal in sport, in which suspense and extraordinary performances are what the spectators want, it may not be so desirable in firms”. Ouch.

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