There seem to be two type of contests, one is usually pretty legit, the other, well, you should definitely check out their terms and conditions:
1) Contests held by creatives, for creatives.
2) Contests held by businesses, for creatives.
The contests held by creatives’, often design communities, purpose is to shine a spotlight on the winner and let them receive the attention that they deserve which is so hard to attain these days. Usually, prizes are minimal, maybe some cash, maybe a t-shirt or a print, the real prize is the attention generated. The contests held by businesses’ purpose are usually stated right up front, but generally that’s a facade to cover up real truth, which is these contests are held to get these businesses some cheap design work. By holding a contest they figure they can drum up a lot of designs to choose from and just select the best from the lot. The prizes for this type of contest are pretty large, but definitely much less than it would cost to hire a designer and have them produce a quality design.
Now, who wants a chance at winning fabulous prizes? And who wants to be exploited?
Lesson of the day: Be careful what you enter, and read the fine print.