Oligopolistic Screening and Two-Way Distortion

Abstract

We analyze the choice of incentive contracts by olipolistic …rms that compete on the product market. Managers have private information and in the …rst stage they exert cost reducing e¤ort. In equilibrium the standard "no distortion at the top" property disappears and two way distortions are optimal. We extend our analysis to other informational, contractual and competitive settings.

Equilibrium Principal‐Agent Contracts: Competition and R&D Incentives

“…Indeed, one can verify that independent goods () lead to equilibrium contracts that are identical to the optimal monopolistic contracts, with no distortion at the top, but imperfect substitutability () leads to the same two‐way distortion of the case with homogenous goods, with extra effort for the most efficient types. Similar results can be derived in case of price competition (see Cella and Etro, ), because the efforts of the firms are still strategic substitutes…”

“…This proposition tells us that the absolute effort levels may increase when the number of firms goes up, but this can happen only for the most efficient types, whereas the effort levels of the least efficient types always decreases with n. This is exactly what can happen in a simple example with only two types (analyzed in detail by Cella and Etro, 2010), in which a shift from monopoly to duopoly can increase effort only for the most efficient types. 10 More generally, when a new firm enters the market, all the managers with productivity above a certain threshold (which depends on the number of firms) are required to exert more effort, and the others end up exerting less effort.…”

“…This implies that a positive correlation between the number of firms (as a proxy of competition) and the strength of the incentive schemes is perfectly consistent with standard principal-agent theory. As shown in Cella and Etro (2010), our analysis applies to other related models, including those based on price competition and spatial competition. Future research could investigate other applications of this form of contract competition and the impact of exogenous shocks, for instance a mean-preserving spread on the distribution of the types, a change in the number of consumers of the market or other structural shocks.…”

“…We should note that other works have identified instances of effort provision above the first best level for the most productive types in violation of the “no distortion at the top” convention, but from different sources such as externalities between multiple agents (Lockwood, ) or learning in dynamic environments with noisy signals (Jeitschko and Mirman, ). Cella and Etro () analyze a two‐types‐two‐firms environment where efforts can be either strategic substitutes or complements, competition can take different forms (patent races, competition in prices à la Hotelling, competition in quantities with complement goods and with investments in advertising), and allow for imperfect correlation across types. Finally, Piccolo () has adopted a framework similar to ours to study the role of information sharing between competing vertical hierarchies.…”

“…However, this is not the case anymore when goods are complements, as with b negative here or in few other cases in which efforts are strategic complements (for instance, when effort is exerted in general advertising for the market). In these cases equilibrium contracts distort downward all the effort levels compared to the symmetric information benchmark (see Cella and Etro, ).…”