Commitment to Inequality and the Optimality of Contests

Abstract

We study optimal incentive contracts with multiple agents when performance evaluation is delegated to a reviewer. The reviewer is biased in favor of the agents, and the degree of the bias is ex ante unknown to the principal. We show that a contest, which is defined as a contract in which the principal commits to allocate a predetermined set of prizes, is optimal. By using an optimal contest, the principal can implement the first-best effort profile and extract all the surplus if and only if agents are risk-neutral. In general, the constrained-optimal effort profile can be uniquely implemented by a contest, in which the principal leaves no rent to the agents.