Designing Managerial Incentives in Competitive Markets

This paper investigates how market competition shapes the design and provision of incentive contracts for managers. We study a moral hazard setting where two principals each employ a risk neutral agent (manager). Each agent makes a decision on effort leading stochastically to an outcome. These outcomes are observable for each principal and used to design incentives based on their joint realizations. We isolate the effect of market competition in two channels: market information and market structure. First, market information captures the correlation between the outcomes generated by the agents. Second, market structure indicates the profits that each principal obtains from a given realization of agents’ outcomes. As a result, the incentive schemes that are optimal from an informational perspective need not be used in equilibrium when competition reduces the returns to effort. This framework provides a unified explanation for variation in incentive design across competitive environments and clarifies how competition affects managerial discipline through the profitability of incentive provision rather than through the design of performance measures.