Competitive Pressure, Incentives and Managerial Rewards

Abstract

The paper examines the equilibrium relationship between managerial incentives and product market competition in imperfectly competitive industries. In a simple managerial economy, where owners simultaneously choose reward schemes and managers are privately informed on firms. production technologies, it is showed that a competing-contracts effect, at play under high powered incentive schemes (contracts based on firms’ profits), may induce competitive pressure to elicit managerial effort. An inverted-U shaped relationship between product market competition, managerial effort and agency costs thus obtains when contracts are based on firms’ profits. Remarkably, whenever competition is strong enough, low powered incentive schemes (contracts based on production costs) may survive in equilibrium with detrimental effects on welfare.competing contracts, cost-target, managerial .rms, pro.t-target, product market competition, vertical hierarchies, X-inefficiency