In many situations, agents exert effort in order to get promoted to a better-paid position, where the reward for that position is fixed and where agents compete among themselves for those positions. Tournament theory considers a group of agents competing for a fixed set of prizes. In this case, all that matters for winning is one’s positions relative to others, rather than one’s absolute level of performance.

(a) Discuss the reasons that a firm might wish to employ the tournament scheme described above. Consider the effects on the incentives of both the firm and the workers.

(b) Discuss the reasons that a firm might not wish to employ the tournament scheme described above. (c) State one specific prediction of tournament theory and provide an example of empirical evidence in support of that prediction