Optimal Upstream SOE's Managerial Delegation and Downstream Industrial Policy Under Successive Duopoly

Abstract

This paper introduces managerial delegation for a state-owned enterprise (SOE) in a successive duopoly model. There are two home firms, one upstream and one downstream, each competing with a respective foreign firm. All firms are private except the home upstream firm which is an SOE with a managerial incentive contract that contains profit and sales elements. The domestic government maximizes social welfare by choosing the optimal managerial contract for the SOE and the optimal industrial policy for the domestic downstream firm. The paper finds that (1) the optimal incentive contract will never be pure profit maximization; (2) if the SOE has a positive weight on its incentive contract, its equilibrium profit margin will be negative; (3) both domestic firms benefit from a lower SOE's profit-incentive weight; and (4) if the foreign input supplier is sufficiently large, the optimal industrial policy is a tax. The paper also finds that, in the linear case, the SOE's profit margin is always negative, the optimal managerial profit weight is determined by all firms' cost parameters, taxing downstream production is optimal under certain demand and cost conditions, and the foreign upstream firm will choose not to engage in a strategic managerial delegation game.