How Does Product Market Competition Shape Incentive Contracts?

Abstract

This paper studies the effect of product market competition on the explicit compensation packages that firms offer to their CEOs, executives and workers. We use a large sample of both traded and non-traded UK firms and exploit a quasi-natural experiment associated to an increase in competition. The sudden appreciation of the pound in 1996 implied different changes in competition for sectors with different degrees of openness. Our difference in differences estimates show that a higher level of product market competition increases the performance pay sensitivity of compensation schemes, in particular for executives.JEL classification: J32, J33, M12, J41, J49

Market competition and executive pay

“…In summary, this research uses sources of variation in product-market competition based on international trade shocks and globalization measures and shows that higher levels of competition led to stronger provision of incentives by firms to their managerial workers in the UK and the US manufacturing sectors [8], [9]. However, international trade shocks and globalization are not the only potential sources of changes in the market structure.…”

“…Some authors study the effects of international trade shocks [8], [9]. Other studies consider the effects of deregulation in the banking and financial sectors on the structure of compensation [10], [11], [12].…”

“…Some studies have analyzed how the implicit incentives provided by increased product-market competition interact with the compensation schemes that firms have with their workers [8]. The data used cover the period 1992-2000 and contain a sample of more than 22,000…”

“…They found evidence that suggests an increase in the sensitivity of pay to performance in response to increases in the competitive pressure of the market [8], [9], [10], [11], [12].…”

Board of Director Collusion, Managerial Incentives and Firm Values

“…Cuñat and Guadalupe (2005) exploit the quasi-natural experiment of the pound sterling appreciation in 1996 to investigate the effect of an exogenous variation in the degree of competition on incentives. They find that stronger competition increases the steepness of performance-related pay.…”