The Impact of Trade Competition on Managerial Incentives and Productivity

Abstract

We study a model of monopolistic competition with firm heterogeneity –in terms of productivity- in which firms provide incentives to managers to reduce marginal cost. In our model managerial incentives are endogenously determined by firm’s productivity and the intensity of competition. We show how tougher competition, generated by large market size or trade, induces stronger incentives to reduce marginal cost for the more-productive firms while the opposite holds for the less-productive firms; this further affects the selection of heterogeneous producers into the domestic and foreign markets. Aggregate productivity growth is decomposed in two sources, within-firm growth and between-firm growth, a decomposition that has not been theoretically analyzed before. We provide a useful theoretical model to analyze how exposure to competition leads to firm productivity growth and how this further affects aggregate performance measures and selection.