Strategic delegation under quality competition (Q698257)

This paper examines strategic manipulations of incentive in a model where firms compete in quality as well as in price. Compensation schemes for managers are based on a linear combination of profits and sales. For a given level of quality, a firm desires to reduce the manager's compensation when product sales increase; this serves as the firm's commitment to raise prices. Nevertheless, in general, a manager has a stronger incentive to produce goods of higher quality if he is compensated according to sales. Therefore a compensation scheme that penalizes a manager when sales increase may result in products that are inferior to those of its rival. The author shows that depending on the nature of quality, a positive weight on sales may be desirable when firms compete in quality and price. Welfare implications are also explored.