Working Paper: CEPR ID: DP1382
Authors: Klaus M. Schmidt
Abstract: 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.
Keywords: managerial incentives; competition; moral hazard
JEL Codes: D20; L14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increased competition (L13) | Increased managerial effort (M54) |
| Increased competition (L13) | Probability of liquidation (G33) |
| Probability of liquidation (G33) | Increased managerial effort (M54) |
| Increased competition (L13) | Reduced profits (D33) |
| Reduced profits (D33) | Less attractive incentive schemes for managers (M52) |
| Increased competition (L13) | Ambiguous total effects on managerial effort (D29) |