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Openness, Managerial Incentives and Heterogeneous Firms

  • Zhihong Yu

Motivated by new evidence that managerial incentives play an important role in determining firm productivity, this paper incorporates the principal-agent mechanism into the new heterogeneous firm trade framework to examine the link between openness and endogenous firm productivity. We show that firm heterogeneity plays a crucial role in the effects of openness on firms’ optimal incentive contracts via the trade-induced “carrot and stick” effect. This mechanism increases the marginal value of managerial effort, which motivates the firm owners (principals) to offer a higher power contract to the managers (agents) to reduce managerial slacks. The intra-firm managerial incentive mechanism stressed in this paper could be viewed as complementary to the inter-firm reallocation effect in the Melitz (2003) model in explaining the observed link between openness and aggregate productivity.

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Paper provided by University of Nottingham, GEP in its series Discussion Papers with number 08/17.

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Handle: RePEc:not:notgep:08/17
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