The Effects of Promotion Incentives on Delegated Investment Decisions : A Note

We report the results of an experiment designed to examine investment project selection under promotion incentives, modeled as tournament contracts. For a given expected return, the owner prefers investments with lower systematic risk. Therefore, to the extent managers select investments other than those yielding the highest risk-adjusted rates of return, they diverge from what the owner desires. In the presence of promotion incentives, we identify a situation in which the maximization of expected compensation by managers is incompatible with their selection of investment projects that maximize the risk-adjusted rate of return. The results indicated that subjects recognize the strategic implications of alternative promotion scenarios and respond to them in an opportunistic fashion