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The Atalanta Effect: How High-Powered Compensation Reduces Risk-Taking

Agents frequently compete for both relative-performance rewards — mutual fund inflows generated by rankings, executive promotions and compensation based on peer comparisons, rank-dependent social status — and absolute-performance rewards — bonus payments for meeting targets, performance fees based on “high-water marks,” wealth from portfolio returns. It is well known that bonus compensation can engender risk-taking. However, we show that introducing bonus rewards into rank-based competitions can reduce risk-taking through the “Atalanta effect”: bonus rewards distract superior competitors from rank competition, thereby leveling the playing field and reducing the need for weak competitors to adopt high downside-risk strategies.