In total compensation practices, what does tournament theory primarily explain?

Tournament theory primarily explains how performance incentives are structured in a competitive environment, particularly when there are high stakes involved. It suggests that organizations can motivate employees by creating a competitive atmosphere, where individuals strive for higher rewards based on their performance relative to others. In this context, the "tournament" refers to the competition for promotions, bonuses, or higher salaries, which incentivizes employees to outperform their peers.

This theory highlights the idea that the pay differences among employees create an environment where individuals will work harder to achieve these rewards, as the potential for a higher payoff encourages greater effort and enhances overall productivity. In sum, tournament theory essentially underscores the importance of the competitive element in performance incentives, focusing on the motivations that lead individuals to aim for higher rewards based on their performance compared to others in the organization.