Rank-Order Innovation Tournaments

Research efforts and outcomes are generally private information of innovative firms: research inputs are unobservable and the value of innovations is difficult to evaluate. This is the reason why rank-order tournaments are more adequate incentive schemes rather than a conventional contracting. The typical model considers a risk-neutral sponsor (commonly governments or private corporations) and a number of risk-neutral or risk-averse contestants, such as research teams, startup companies. The contestants are competing to find the "best" innovation. The winner obtains the prize and the losers get nothing in a "winner-take-all" game. The prize is thus awarded by the sponsor on the basis of relative rank rather than on the absolute performance. An innovation tournament belongs to the class of dynamic $n$-player two-stage games of imperfect information: at the "entry stage" each firm decides whether to participate, at the "contest stage" each contestant decides whether to invest in each period without knowing the rivals' choices. The game is solved by backward induction. Provided the objective function is quasiconcave, the tournament subgame has a unique symmetric equilibrium in pure strategies. This contribution reviews the innovation tournament models for different probability distributions of shocks.