Managerial Incentives and Competition

Abstract

This paper experimentally tests the impact of managerial incentives on competitive (market) outcomes. We use a Cournot duopoly game to show that when managers’ incentives are based on the firm’s absolute performance (profits), collusion can be sustained. However, when managers’ incentives are based on the firm’s relative performance (their profits relative to the other firm’s profits), this drives the market to the competitive and efficient outcome. These results suggest that regulators need to consider not only the number and concentration of firms in an industry, but also the managerial compensation schemes when deciding how much intervention is appropriate in a given industry.