COMPETITION, LONG-RUN CONTRACTS AND INTERNAL INEFFICIENCIES IN FIRMS

Internal reward structures in firms are often integral parts of their 'culture', and are changed infrequently in comparison to decisions about e.g., prices. This paper investigates how this feature of firm organization provides a mechanism through which product-market competition affects firms' internal efficiency. The design of firms' internal organization is modeled as a choice of an incentive structure between a principal and an agent, with strategic implications for firm's competitive positions on the product market. It is shown that - contrary to popular beliefs - there may be a negative relation between the competitiveness of the product market and effort incentives.