The effect of competition in contests: A unifying approach

TL;DR

This paper provides a comprehensive analysis of how increased competition through prize inequality impacts effort in contests, revealing conditions under which competition encourages or discourages effort and establishing the optimality of winner-takes-all contests.

Contribution

It introduces a unifying approach to analyze effort in contests with finite and continuum type-spaces, resolving open questions about contest optimality under various cost structures.

Findings

Competition can either increase or decrease effort depending on type likelihoods.

The winner-takes-all contest is robustly optimal under linear and concave costs.

The unifying method applies to both complete and incomplete information environments.

Abstract

We study how increasing competition, by making prizes more unequal, affects effort in contests. In a finite type-space environment, we characterize the equilibrium, analyze the effect of competition under linear costs, and identify conditions under which these effects persist under general costs. Our findings reveal that competition may encourage or deter effort, depending on the relative likelihood of efficient versus inefficient types. We derive implications for the classical budget allocation problem and establish that the most competitive winner-takes-all contest is robustly optimal under linear and concave costs, thereby resolving an open question. Methodologically, our analysis of the finite type-space domain -- which includes complete information as a special case and can approximate any continuum type-space -- provides a unifying approach that sheds light on the contrasting results in these extensively studied environments.