Product Market Competition and Agency Costs

Abstract

We model the effects of product market competition on managerial efficiency, and isolate the agency effect of competition, which is present only in firms subject to agency costs, from the direct pressure effect, which is present in all firms. Using a unique set of Canadian data which allows us to simultaneously observe the characteristics of firms as well as their employees, we then evaluate the empirical significance for these two effects. We find that competition has both a significant direct pressure effect, as well as a significant agency effect. Both effects increase the importance firms place on quality improvements and on cost reductions, as well as contractual incentives and employee effort.

Keywords: competition, incentives, agency costs, entrepreneurial firms vs. large corporations

JEL Classification: L13, L15, M52