Relative performance evaluation and contract externalities

Relative performance evaluation and contract externalities

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Article ID: iaor200973146
Country: Germany
Volume: 32
Issue: 1
Start Page Number: 1
End Page Number: 20
Publication Date: Jan 2009
Journal: OR Spectrum
Authors: ,
Abstract:

We consider the incentive characteristics of optimal linear contracts based on relative performance evaluation (RPE) for managers under moral hazard in imperfectly competitive product markets. Each contract influences the quantity choices of all competing agents causing contract externalities that affect the principals' contracting game. We analyze the relations between the optimal extent of RPE and several firm and market characteristics, allowing for heterogeneous firms and idiosyncratic firm risk. In general, we find non-monotonic comparative static results regarding the influence of market and firm-specific risk, the industry's competitiveness, and the correlation of the firms' profit.

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