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Endogenous Managerial Contract

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Abstract

The relationship between managerial incentives and product market competition is studied in an imperfectly competitive industry where two managerial .rms, compete by setting quantities. Owners simultaneously choose between two contractual regimes: a cost-based and a profit-based one, while privately informed managers perform an unveri.able cost-reducing activity and choose quantities. We characterize the incentive properties of alternative managerial remuneration schemes owners may use to control managers.behavior and we study the equilibrium relationship between owners’ and managers’ choices, efficiency and market competition. It is showed that a competing-contracts effect, at play under profit target, may induce firm owners not to select the constrained efficient allocation in the pre-specified set of contracts. Moreover, under profit-based schemes a pure agency effect, at play directly through information rents, drives a positive impact of competition on managerial effort. As a result an inverted-U shaped relationship between product market competition, managerial effort and agency costs obtains, thus leading to marginal costs convex with respect to a measure of competition.

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Bibliographic Info

Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 148.

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Date of creation: 01 Nov 2005
Date of revision: 01 Jul 2006
Publication status: Published in International Journal of Industrial Organization, 2008, Vol. 26, Issue 6, Pages 1257-1460
Handle: RePEc:sef:csefwp:148

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Keywords: competing contracts; cost-target; managerial .rms; pro.t-target; product market competition; vertical hierarchies; X-inefficiency;

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Cited by:
  1. Salvatore Piccolo & David Martimort, 2006. "The Strategic Value of Incomplete Contracting in a Competing Hierarchies Environment," CSEF Working Papers 160, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 08 Dec 2006.
  2. N. Lacetera & L. Zirulia, 2008. "Knowledge Spillovers, Competition, and R&D Incentive Contracts," Working Papers 624, Dipartimento Scienze Economiche, Universita' di Bologna.

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