The effect of incentive contracts on the market equilibrium

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I consider incentive contracts for CEOs in duopolies and their influence on the market equilibrium as well as the efficiency. Therefore, I first derive a theoretical model based on Fershtman and Judd (1987) and transformed by including demand uncertainty. However, this approach neglects the influence of the risk preferences on the decision-making process, caused by the uncertainty of demand, and thus the achieved market equilibrium. Therefore, a new model incorporating different risk-preferences, based on Broll et al. (2012), is applied instead. This model is then tested through an online pilot experiment. The experimental results do not support the prediction that incentive contracts lead to redistribution of the outcome in a duopoly. this could be due to the small sample size and the associated noise. The variance of demand uncertainty, however, seems to have a significant influence on decision making. Therefore, the absence of an effect in incentive contracts could also be due to an insufficient distinctiveness of the contract types used in the experiment. At the same time, however, it can be seen from the results that managers privatise gains, while the risk and thus losses are compensated by the shareholders and thus socialised.
Faculteit der Managementwetenschappen