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Higher School of Economics,

Department of Finance

“Absolute versus Relative Evaluation in Contract Theory”


February 2013


Kosmas Marinakis, Ph.D.

Assistant Professor,

ICEF and Faculty of Economics


A copy of the lecture slides is available here.



The lecture will take place on February 11, 15:10 – 18:00 at room 3317.

The lecture focuses on the analysis of current issues in the investigation of one of the most current areas of microeconomics: the theory of incentives provided through contracts. We will investigate the differences between the two major approaches in the investigation of contracts: the relative and the absolute performance evaluation. The two approaches will be researched under various assumptions such as limited liability, liquidity constraints, peer effects, commission limits and a number of assumptions for the risk aversion structure, the contract setup and the agent characteristics.

As established in the seminal papers of Lazear and Rosen (1981), Holmström (1982), Green and Stokey (1983) and Nalebuff and Stiglitz (1983), absent any considerations similar to those under investigation in the proposed project, the relative performance evaluation is superior to the absolute performance evaluation from the principal’s point of view. Relative performance evaluation constitutes a move closer to the First Best. This is because relative performance evaluation partially alleviates the agents' moral hazard problem by providing information about the value of common shocks. The principal filters away common shocks from the responsibility of agents and charges a premium for this insurance. The move from absolute performance schemes to relative schemes is Pareto improving because the principal's expected profit increases without hurting the agent.

However, the reality of how real world contracts are implemented is teaching us a different story. Relative contracts, even though they are considered to be a superior method of compensation, they are not the most popular contracts even in industries that fulfill all the prerequisites for the use of such contracts (e.g., industries that have multiple comparable agents who exhibit high correlation in their production shocks). Recent advancements in the literature have shown that the superiority of relative contracts may not carry over when one imposes realistic constraints that deviate from the baseline model developed by Lazear and Rosen as they used an approach free of institutional constraints in the contracting agreement between the principal and the agent. Moreover, even when the seminal result of the superiority of relative contracts does carry over under various realistic assumptions, the economic intuition behind the result is one of significant interest.


Theoretical Papers

 1.  Rank-Order Tournaments as Optimum Labor Contracts
Edward P. Lazear, Sherwin Rosen
Journal of Political Economy, Vol. 89, No. 5 (Oct., 1981), pp. 841-864

 2.  Prizes and Incentives: Towards a General Theory of Compensation and Competition
Barry J. Nalebuff, Joseph E. Stiglitz
The Bell Journal of Economics, Vol. 14, No. 1 (Spring, 1983), pp. 21-43

 3.  Moral Hazard in Teams
Bengt Holmstrom
The Bell Journal of Economics, Vol. 13, No. 2 (Autumn, 1982), pp. 324-340

 4.  A Comparison of Tournaments and Contracts
Jerry R. Green, Nancy L. Stokey
Journal of Political Economy, Vol. 91, No. 3 (Jun., 1983), pp. 349-364

 5.  Rank-Order Contracts for a Principal with Many Agents
James M. Malcomson
The Review of Economic Studies, Vol. 53, No. 5 (Oct., 1986), pp. 807-817

 6.  Optimal Incentive Schemes with Many Agents
Dilip Mookherjee
The Review of Economic Studies, Vol. 51, No. 3 (Jul., 1984), pp. 433-446

 7.  The Agent-Agents Problem: Payment by Relative Output
H. Lorne Carmichael
Journal of Labor Economics, Vol. 1, No. 1 (Jan., 1983), pp. 50-65

 Empirical Papers

1.  Behavioral and Welfare Effects of Tournaments and Fixed Performance Contracts: Some Experimental Evidence
Steven Wu, Brian Roe
American Journal of Agricultural Economics, Vol. 87, No. 1 (Feb., 2005), pp. 130-146

 2.  Regulating Broiler Contracts: Tournaments versus Fixed Performance Standards
Theofanis Tsoulouhas, Tomislav Vukina
American Journal of Agricultural Economics, Vol. 83, No. 4 (Nov., 2001), pp. 1062-1073

 3.  Testing the Theory of Tournaments: An Empirical Analysis of Broiler Production
Charles R. Knoeber, Walter N. Thurman
Journal of Labor Economics, Vol. 12, No. 2 (Apr., 1994), pp. 155-179

 4.  Tournaments and Piece Rates: An Experimental Study
Clive Bull, Andrew Schotter and Keith Weigelt
Journal of Political Economy, Vol. 95, No. 1 (Feb., 1987), pp. 1-33


 The presentation class will be held on February 18, 15:10 – 18:00 at room 3317.

 Your task is to summarize and present one of the following papers:

 1.  Incentives in Tournaments with Endogenous Prize Selection
Christine Harbring and Bernd Irlenbusch
Journal of Institutional and Theoretical Economics (JITE) / Zeitschrift für die gesamte Staatswissenschaft , Vol. 161, No. 4 (December 2005), pp. 636-663

 2.  U-Type versus J-Type Tournaments
Matthias Kräkel
Journal of Institutional and Theoretical Economics (JITE) / Zeitschrift für die gesamte
Staatswissenschaft, Vol. 158, No. 4 (December 2002), pp. 614-637

 3.  Positive Self-Image In Tournaments
Luís Santos-Pinto
International Economic Review, Vol. 51, No. 2 (May 2010), pp. 475-496

4.  Rank-Order Tournaments and Incentive Alignment: The Effect on Firm Performance
Jayant R. Kale, Ebru Reis, Anand Venkateswaran
The Journal of Finance, Vol. 64, No. 3 (Jun., 2009), pp. 1479-1512

 5.  An Experimental Test of Sabotage in Tournaments
Donald Vandegrift, Abdullah Yavas
Journal of Institutional and Theoretical Economics (JITE) / Zeitschrift für die gesamte
Staatswissenschaft, Vol. 166, No. 2 (June 2010), pp. 259-285

 6.  Prize Structure and Information in Tournaments: Experimental Evidence
Richard B. Freeman and Alexander M. Gelber
American Economic Journal: Applied Economics, Vol. 2, No. 1 (Jan 2010), pp. 149-164

 7.  Contests with Multi-Tasking
Derek J. Clark and Kai A. Konrad
The Scandinavian Journal of Economics, Vol. 109, No. 2, The Nobel Memorial Prize in Economics, 2006 (Mar., 2007), pp. 303-319

 8.  Tournaments with Prize-setting Agents
Kristoffer W. Eriksen, Ola Kvaløy, Trond E. Olsen
The Scandinavian Journal of Economics, Vol. 113, No. 3 (September 2011), pp. 729-753

 9.  Tournaments Without Prizes: Evidence from Personnel Records
Jordi Blanes i Vidal and Mareike Nossol
Management Science, Vol. 57, No. 10 (October 2011), pp. 1721-1736


Presentation guidelines PLEASE READ CAREFULLY !! 

1.  Each presentation will last 20 min. This means that I expect something between 12 – 20 slides.

2.  The presentation and slides must be in English.

3.  Each presentation will be done by two students at the same time on the floor. This means that one person starts the presentation and at some point passes the floor to the other presenter to continue. More than one couple of presenters from the same group may take the floor.

4.  The order in which groups will take the floor will be random and selected by me.

5.  During the presentation I may ask you to skip some parts and focus on other parts.

6.  The presenters must be prepared to answer questions on their work during or after the presentation.

Summary report guidelines 

1.  Your summary report must be in English.

2.  The report should be between 900 – 1100 words.

3.  The summary report is supporting material for your presentation so the two should be along the same lines.

How to work  

1.  Your work should have 2 equally important sides: the ‘technical’ and the ‘intuitive’. You must be able to explain how the paper is done technically but also, be able to explain the motivation and the results intuitively. Do not fill your presentation with math and technicalities because you will lose the point.

2.  Try to explain the paper as you understand it. In your own way. Be creative. Do not limit yourselves in the way the authors thought about the problem.

3.  Keep your slides short. Most presenters don’t know that but the audience does not read the slides. The slide is a visual aid to help the audience listen to the story you are telling. Do not have a bunch of heavy slides with 200 words each. Have simple, up to the point slides which will help YOU to tell the story better.

4.  Don’t be scared about your English. My English is not perfect either.

5.  Be aware that plagiarism is academically unacceptable and will not be tolerated.

 Seminar process PLEASE READ CAREFULLY !!

 Each group will elect a foreperson’ who will be the head of the group and the responsible person for communication with me.

 In the beginning of the seminar class on February 18 between 15:00 – 15:20, the forepersons will have to:

- hand me a printout of the slides (2 slides per sheet)

- hand me a printout of the summary report

- inform me about the group and the presenters.

Failure to hand me the above material by the beginning of the class will result in a 25% decrease in the group's task mark and 50% decrease in the foreperson’s mark.

Before each presentation the foreperson will have to copy the presentation file(s) to the projection laptop. Just bring a flash drive with your file(s).

Within 24 hours from the completion of the presentation class the forepersons will have to email me at kmarinakis@hotmail.com both the report and the presentation slides (doc, pdf or ppt format).

The seminar class will be a PROFESSIONAL EVENT. This means that everyone has to pay attention and respect the presenters. During the presentations of other groups no one is allowed to talk, be on a computer or another electronic device, prepare for his/her own presentation. Unprofessional behavior will not be tolerated.



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