Strategic Managerial Compensation Arising From Product Market Competition

Abstract

We develop a model in which, first, firms design compensation schemes for their managers while subject to moral hazard and, second, firms compete in Bertrand or Cournot fashion in the product market. We derive the strategic properties of managerial compensation levels and incentives. We show that the implications include: greater systematic risk may weaken the incentives of one firm while strengthening those of a competitor; an increase in the idiosyncratic risk of a firm causes all its competitors to adjust their incentives; and strategic considerations may account for the rise in U.S. CEO pay and the use of incentives.