Have you ever wondered why your incompetent boss makes so much more than you?  Well, economists have an answer, tournament theory.  Developed about 30 years ago, tournament theory suggests that most offices are a tournament where differing workers compete for a prize, which is usually given in the form of a promotion.  Tournament theory suggests that your boss’ pay is not so large because he or she deserves it, but because it is meant to motivate you.

Does the pay difference between you and your boss have to be so large?  At first glance, the answer would seem to be yes.  Let’s take an example of a payment compensation scheme at the fictional but squeaky Rubber Duck Company.   The manager tells the workers that whoever makes the most rubber ducks gets $100 and everyone else at the company will make only $40.  The workers know they are guaranteed $40 and would only put in up to $60 worth of additional effort in order to get the prize; anything else would be a loss.  Realizing this, the manager changes the pay scheme, telling the workers that the winner gets $100 and the loser gets $10, thus increasing the amount of work that each worker will put in to approximately $90.

But first glances can be deceiving.  As the working season begins, workers begin sabotaging one another.  Also, some workers who were previously able to try and put in the $60 of extra effort have cut back entirely because they know they will never be able to produce $90 of extra work like some of their more able coworkers. Finally, one worker notices that a rival company, Quackers, which is currently hiring, is planning on giving their workers the same deal as the Rubber Duck Company except the top prize if $65 and the bottom is $40. Realizing that working at Quackers guarantees $40 and would only require up to $25 of extra work, many workers leave the Rubber Duck Company and their over-competitive manager.

So what’s better, a large spread or a small spread?  Like most things in economics, there is an equilibrium point.  Far from being perfect, this point may end up discouraging a whole lot of workers, especially when there is luck and protectsia involved.  One solution to this is to offer a few different prizes.  Suppose the Rubber Duck Company offered $90 to the best worker, $70 to several runner ups and $40 for the rest.  With not so much of their pay at risk, workers would be less antagonistic, perhaps even helping one another in alliances.  These workers may also take a shot to win the prize, whereas in the past, the out-of-reach goal was discouraging.

In a recent round of negotiation between the Israeli Medical Association, tournament theory, whether using its name or not, was among the many, many issues discussed.  Doctors have been leaving the public sector for many reasons, one of which is a lack of advancement.  In a standard department of a hospital, there are two levels, regular doctor and department head, a position held until retirement.  As a compromise, a new position between regular doctor and department head, or second tier prize, has been offered.  This new position will be called ” service manager.”

This compromise gives me hope.  Creating an in-between level is the obvious solution to discrepancies that are way too high.  Perhaps in time, there will be less department heads, and more service managers who will become the new de-facto department heads with pay discrepancies not as insane as the ones currently in place.  I am curious to see if this works and I am even more curious to see if it can be applied to office life as well.  Perhaps creating loopholes around the levels of bureaucracy ordained by the government and accepted business practice, we can deal with the income disparity in Israel without the need for a socialist revolution.  Or maybe I am too optimistic.  Perhaps we need the pendulum to swing the other way in order to get better social benefits and address the growing income disparity in Israel.

What do you think?