Welfare-reducing price competition under relative performance delegation with convex costs

Abstract

Price competition is thought to be more intense than quantity competition in oligopolies. By introducing strategic delegation contracts, this study challenges this belief. We consider management reward contracts based on relative performance, which is observed globally. We show that if marginal costs are increasing, quantity competition yields lower prices, smaller profits, and greater welfare than price competition. Then, we endogenize the mode of competition and find that both price and quantity competition can exist in equilibrium. Finally, we extend our analysis to include a mixed duopoly wherein a state-owned public firm competes with a private firm. We determine that the welfare-inferior outcome (price competition) appears in the unique equilibrium. Our findings suggest that price competition does not necessarily imply stricter competition among firms in either private or mixed oligopolies, which is important from an antitrust perspective. They also imply that coordination among firms regarding the mode of competition (contract form) may be harmful to society and should be monitored by antitrust agencies.