When Randomization in Collective Tournaments is Protable for the Principal

In the context of principal-agent theory risk is largely seen as a source that causes ine¢ ciencies and lowers incentives and accordingly is not in the principal’s interest. In this paper I compare two di¤erent designs of a collective tournament where output in a team is generated through a particular two-stage production process. I show within a theoretical tournament framework that risk in terms of chance is bene…cial from the point of view of a pro…t maximizing principal who organizes the tournament. Selecting an agent randomly that has to work at the …nal stage after all agents exerted e¤ort at the …rst stage helps the principal to overcome a trade-o¤ in incentive provision he faces when selecting the agent who works at the …nal stage before the tournament starts. This trade-o¤ causes optimal e¤orts to be lower in a tournament without random selection compared to a tournament with random selection. As the higher e¤orts overcompensate additional wage costs the principal earns higher expected pro…ts when selecting the agent that has to work at the second stage randomly after the …rst stage.