DP1382 Managerial Incentives and Product Market Competition

Author(s): Klaus M. Schmidt
Publication Date: April 1996
Keyword(s): Competition, Managerial Incentives, Moral Hazard
JEL(s): D20, L14
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1382

The paper shows that an increase in competition has two effects on managerial incentives: it increases the probability of liquidation, which has a positive effect on managerial effort, but it also reduces the firm?s profits, which may make it less attractive to induce high effort. Thus, the total effect is ambiguous. The paper identifies natural circumstances where increased competition unambiguously reduces managerial slack. In general, however, this relation need not be monotonic. A simple example demonstrates that ? starting from a monopoly ? managerial effort may increase as additional competitors enter the market, but will eventually decrease when competition becomes too intense.