This paper analyses a multiple prize contest model with expectation-based
loss averse contestants a la Koszegi and Rabin (2006, 2007). Contestants simultaneously
exert costly effort and prizes are allocated to the contestants
with highest effort. A contestant's cost of effort depends on his effort level as
well as his ability, which is private information. The contest designer maximizes
the total expected effort by allocating a limited amount of resources into
prizes. The model is able to align the empirical evidence on effort provision,
which is hard to reconcile with the standard economic assumptions. More
specically, high-ability contestants overexert effort while low-ability contestants
withhold effort in comparison to the predictions of standard preferences.
Moreover, the optimal prize allocation differs markedly in the presence of lossaverse
contestants: multiple prizes becomes optimal in the cases where the
standard preferences predict the optimality of a single grand prize.