Promotion Tournaments in Market Equilibrium

Standard models of promotion tournaments assume that …rms can commit to arbitrary tournament prizes. In this paper, a …rm’s ability to adjust tournament prizes is constrained by the outside labor market, through the wages other …rms are willing to o¤er to the promoted and unpromoted workers. The paper shows that su¢ ciently patient …rms may be able to retain some control over the tournament prizes through a relational contract, but if the …rms are competitive, full e¢ ciency does not obtain in equilibrium even for discount factors arbitrarily close to one. Full e¢ ciency, however, may be feasible in …rms with supranormal pro…ts (monopolistic …rms). The paper also shows that a minimum wage regulation distorts the workers’ investments in human capital by restricting the …rms’abilities to design e¢ cient promotion tournaments. A minimum wage thus leads to underinvestment in competitive …rms, but could lead to excessive human capital accumulation in monopolistic …rms. I thank Dan Bernhardt, Jed DeVaro, Bob Gibbons, Hodaka Morita, Michael Raith, and Mike Waldman for helpful comments and suggestions. Financial support from the Social Sciences and Humanities Research Council of Canada is gratefully acknowledged.