Institutions, contracts, and asset market prices

Abstract

Tournament incentives have been extensively analyzed, and recommended as policy, by economists and compensation consultants alike. Analysis of tournaments typically looks at the effect of tournament contracts for individuals on individual behavior in non-market settings (public good provision, team tasks, etc.). In contrast, this work investigates the effect of tournament contracts for individual agents on market performance. In particular, this work investigates the effect on asset market performance of individual contracts that reward "beating the market". To this end, both theory and laboratory experiments are employed. The theoretical prediction that the rational expectations equilibrium is destroyed by the introduction of "beat the market" contracts is overwhelmingly supported by the experimental data.