Agency Problems in a Competitive Conglomerate with Production Constraints

This study explores the reciprocal effects between agency problems and market competition. We develop an adverse selection model of a competing conglomerate with production constraints. The conglomerate participates as the leader in two different duopolistic markets with a Stackelberg-Cournot framework and heterogeneous goods. The conglomerate is run by its headquarters and two division managers. The agency problem arises because the market demand size is a manager's private information, which the headquarters try to elicit by a contract mechanism. We fully characterize a first and a second-best contract. When the production constraints make the first best outcome unattainable, the second-best contract is either separating or pooling, depending on the severity of the constraints. The separating second-best contract sometimes improves the ex-ante welfare in comparison to a symmetric information benchmark. The pooling second-best contract never improves the ex-ante welfare. We also find that at an intermediate level of substitutability, the second-best contract is most likely to coincide with the first-best one, and any departure from that level toward either substitutability or complementarity makes the attainment of the first-best outcome less likely.