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Openness, managerial incentives, and heterogeneous firms

  • Zhihong Yu

    ()

This paper examines the effects of trade openness on managerial incentives and firm-level productivity by incorporating the principal-agent mechanism into the heterogeneous firm trade framework inter alia Melitz (Econometrica 71:1695–1725, 2003 ). We show that opening up to trade generally leads to a steeper optimal managerial incentive scheme (and hence, higher firm productivity) via a new mechanism by which selection of heterogeneous firms into the export market plays a key role. This is because trade openness unambiguously increases the variation of firm profits by reallocating profits towards ex post low-cost exporters, leading to a higher stake of the market game faced by the principals. Interestingly, it is further shown that, whilst falling variable trade costs unambiguously increase managerial incentives, a reduction in fixed trade costs could possibly lead to weaker incentives and thus generate productivity losses due to an adverse inter-firm reallocation effect. Hence, the model establishes a causal link between the Melitz-type reallocation effect and the within-firm productivity changes, both of which have been identified as important sources of aggregate productivity gains from trade by recent empirical studies. Copyright Springer-Verlag 2012

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File URL: http://hdl.handle.net/10.1007/s00199-010-0595-1
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Article provided by Springer in its journal Economic Theory.

Volume (Year): 51 (2012)
Issue (Month): 1 (September)
Pages: 71-104

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Handle: RePEc:spr:joecth:v:51:y:2012:i:1:p:71-104
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  1. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
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