Optimal Award Scheme in Innovation Tournaments

In an innovation tournament, an organizer solicits innovative ideas from a number of independent agents. Agents exert effort to develop their solutions, but their outcomes are unknown due to technical uncertainty and/or subjective evaluation criteria. To incentivize agents to make their best effort, the organizer needs to devise a proper award scheme. While extant literature either assumes a winner‐take‐all scheme a priori or shows its optimality under specific distributions for uncertainty, this paper derives necessary and sufficient conditions under which the winner‐take‐all scheme is optimal. These conditions are violated when agents perceive it very likely that only few agents receive high evaluation or when a tournament does not require substantial increase in agents’ marginal cost of effort to develop high‐quality solutions. Yet, the winner‐take‐all scheme is optimal in many practical situations, especially when agents have symmetric beliefs about their evaluation. In this case, the organizer should offer a larger winner prize when he is interested in obtaining a higher number of good solutions, but interestingly the organizer need not necessarily raise the winner prize when anticipating more participants to a tournament. The online appendix is available at https://doi.org/10.1287/opre.2016.1575.