DP4506 Managerial Incentives and Collusive Behaviour

Author(s): Giancarlo Spagnolo
Publication Date: July 2004
Keyword(s): collusion, corporate governance, delegation, earnings management, executive compensation, income smoothing, oligopoly, ownership and control
JEL(s): D43, G30, J33, L13, L21
Programme Areas: Financial Economics, Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=4506

I characterize the effects of empirically observed managerial incentives on long-run oligopolistic competition. When managers have a preference for smooth time-paths of profits – as revealed by the empirical literature on ‘income smoothing’ – manager-led firms can sustain collusive agreements at lower discount factors. Capped bonus plans and incumbency rents with termination threats make collusion supportable at any discount factor, independent of contracts’ duration. When managers have these preferences/incentives and demand fluctuates, ‘price wars during booms’ need not occur: the most collusive price may then be pro-cyclical. Corporate governance codes invoking transparency may reinforce these effects.