Delegation Games: A Game Theoretical Perspective for Managerial Incentives

Abstract

Companies employ managers for either practical, legal or administrative reasons. However, no matter what the reason, the good performance of managers and the success of companies are vital elements for firms. At this point, managerial incentives play a key role. In this paper, we use the VFJS model proposed by Vickers (1985), Fershtman and Judd (1987) and Sklivas (1987). We assume that owners in a duopoly each hire a manager with a publicly observable contract which is not renegotiable. The remuneration of a manager consists of a fixed part and a bonus (incentive), which can be based on pure profits, sales, relative profit or market share.We assume that firms have different marginal costs. We find that even an inefficient firm can obtain Stackelberg leadership profits if it compensates its manager with a market share or a relative profit incentive whereas its rival is just owner-led. We also consider duopolies where the efficient firm remunerates its manager with a market share incentive and the rival firm uses a sales, a relative profit or a market share incentive. We find that the efficient firm could achieve Stackelberg leadership profits if the difference between marginal costs of two firms exceeds a certain benchmark. Finally, we determine that the less efficient firm owner always prefers to use a managerial bonus based on relative profits. If the difference between marginal costs is large enough, the owner of the more efficient firm prefers to use a managerial bonus based on market share.