Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2013/13: Teams and Tournaments in Relational Contracts

Ola Kvaløy () and Trond E. Olsen ()
Additional contact information
Ola Kvaløy: UiS Business School, University of Stavanger, Postal: University of Stavanger , UiS Business School, 4036 Stavanger, Norway
Trond E. Olsen: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: This paper analyses and compares optimal relational contracts between a principal/firm and a set of agents when (a) only aggregate output can be observed, and (b) individual outputs can be observed. We show that the optimal contract under (a) is a team incentive scheme where each agent is paid a maximal bonus for aggregate output above a threshold and a minimal (no) bonus otherwise. The team’s efficiency decreases with its size (number of agents) when outputs are non-negatively correlated, but may increase considerably with size if outputs are negatively correlated. In the case where individual output can be observed, we show that the optimal contract is a tournament scheme where the conditions for an agent to obtain the (single) bonus are stricter for negatively compared to positively correlated outputs. We finally show that if agents have bargaining power, firms may deliberately choose to organize production as a team where only aggregate output is observable. The team alternative is more likely to be superior under negatively correlated outputs.

Keywords: Relational Contracts; team incentive scheme; tournament

JEL-codes: D00; D20; D21; D80; D86

55 pages, December 30, 2013

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