17/06/2008
Do Firms' Owners Delegate both Short-Run and Long-Run Decisions to Their Managers in Equilibrium?

Do Firms' Owners Delegate both Short-Run and Long-Run Decisions to Their Managers in Equilibrium?

The present paper explores the scope of strategic delegation, to the firms' R&D investments and market competition in a Cournot Oligopoly.

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It is considered a stylized fact that modern corporations are characterized by a separation of ownership and management, or in other words, delegation of decisions from owners to managers (Fama and Jensen 1983). So far, literature focuses on two kinds of delegation. The first derives from the ownersíneed to exploit specific competencies that certain individual managers may embody, in order to improve the efficiency of their firms under asymmetry of information and moral hazard. This kind of delegation is thoroughly examined by using principal-agent models. The second is related to the acquisition of commitment ability that allows firms' managers to render credible strategies that the owners themselves are unwilling to choose. In particular, the owner of a firm may change the behavior of a rival firm in his favor, by hiring a manager whose preferences are di§erent from his own. This sort of delegation has prevailed in the literature as "strategic delegation" and was introduced by the seminal contribution of Schelling (1960).

The strategic use of managerial incentive contracts has been introduced by Vickers (1985), Fershtman (1985), Fershtman and Judd (1987) and Sklivas (1987) or VFJS here forth. In these papers, each owner has the opportunity to compensate his manager with an incentive contract combining own profits and sales or revenues, in order to direct him to a more aggressive behavior in the market. Early empirical studies (Baker et al., 1988; Jensen and Murphy, 1990; Lambert et al., 1991) suggest that CEO compensation is positively associated with both profit and sales. Industry level analyses suggest that contracts of this type are widely adopted in the CEO compensation practice in US markets with high R&D investments such as the new economy firms (Nourayi and Daroca, 2008), the US electric utility industries (Duru and Iyengar, 1999).

The strategic delegation of both short run and long run decisions such as R&D investments was introduced by Zhang & Zhang (1997). They examine strategic delegation assuming that owners exogenously select either to delegate both type of decisions or none. Yet, empirical evidence show that some Örmsíowners tend to delegate only short-run decisions to their managers, while others delegate long-run decisions as well (Colombo and Delmastro, 2004).

Our paper differentiate from the relevant literature by permitting firms' owners to endogenously select between two alternative strategies: either Full Delegation (FD), in which they delegate both short-run (output) and long-run (R&D investments) decisions to their managers or Partial Delegation (PD), in which case they delegate only short-run decisions to their man- agers. In particular the present paper attempts to address the following questions. First, which are the strategic interactions that arise between duopolistic Örms, when Örms ownersí alternative strategies are either Full Delegation or Partial Delegation? Second, which strategy will prevail in equilibrium? More specifically is the equilibrium sensitive to the assumption of existence of ex ante commitment of Örmsíowners regarding to the strategy that they will follow? Third, which are the welfare e§ects of each delegation configuration?

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