Why Do Socially Concerned Firms Provide Low-Powered Incentives to Their Managers?

Abstract

We introduce a mixed quantity-setting duopoly with a socially concerned firm and a profit-maximizing firm to derive a firms' optimal combination of the organization's type, the structure of managerial compensation and its manager's type. Both firms delegate the quantity choice to managers who can be either selfish -- solely interested in monetary compensation -- or intrinsically motivated -- partially interested in the goal of the firm. Although we show that both firms prefer to hire an intrinsically motivated manager to save on compensation costs, only for the socially concerned firm it has a strategic value. The structure of the manager's optimal compensation contract depends on the organization's type. The profit-maximizing firm always prefers to use strategic incentives based on profit and sales revenue. In contrast, for the socially concerned firm it is preferable to use a fixed wage to compensate its manager if the level of social concern is sufficiently high. We further discuss the endogenous choice of an optimal social strategy and demonstrate that in a strategic setting profit-maximizing investors might benefit if they commit to consider the welfare of consumers and rely on the intrinsic motivation of the firm's manager. In short, our paper studies the optimal combination of three different commitment devices in a duopoly and provides a justification for the recent increase of social responsibility as a competitive strategy and the widespread use of low-powered incentives in socially concerned firms.