Abstract

This paper introduces the relative-performance contract into a vertically differentiated product market and examines how the optimal trade policy and quality choice respond to the incentive mechanism. We find that the high quality firm makes better use of the delegation than the low quality firm in a cross-border decentralized model. The main difference between the present paper and the strategic trade theory literature is that in this paper the optimal policy is free trade, which does not depend on whether firms compete by prices or quantities, and on whether the goods are substitutes or full complements.

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