Tournaments with Managerial Discretion

We study tournaments with managerial discretion in hiring. A manager selects a coworker from a pool of candidates and then competes against him in a Lazear–Rosen–style tournament with a prize equal to a share of total output. A profit-maximizing principal sets the prize share together with a head start (or handicap)—an advantage (or disadvantage) in the output comparison—granted to the manager. The head start affects output through three channels: (i) encouraging the manager, (ii) discouraging the new hire, and (iii) inducing the manager to hire a stronger candidate. The hiring effect dominates the discouragement effect until the strongest candidate is hired; beyond that point, any further head start discourages the new hire more than it encourages the manager. The optimal contract therefore grants a head start just large enough to induce the manager to hire the strongest candidate.