Strategic Delegation under Quality Competition

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Abstract

This paper examines strategic manipulations of incentive contracts in a model where firms compete in quality as well as in price. Compensation schemes for managers are based on a linear combination of profits and sales. For a given level of quality, a firm desires to reduce the manager's compensation when product sales increase; this serves as the firm's commitment to raise prices. Nevertheless, in general, a manager has a stronger incentive to produce goods of higher quality if he is compensated according to sales. Therefore, a compensation scheme that penalizes a manager when sales increase may result in products that are inferior to those of its rival. We show that, depending on the nature of quality, a positive weight on sales may be desirable when firms compete in quality and price. Welfare implications are also explored.

Original languageEnglish
Pages (from-to)25-56
Number of pages32
JournalJournal of Economics/ Zeitschrift fur Nationalokonomie
Volume73
Issue number1
Publication statusPublished - 2001

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Keywords

  • Delegation
  • Incentive scheme
  • Price competition
  • Quality competition

ASJC Scopus subject areas

  • Business, Management and Accounting(all)
  • Economics and Econometrics

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