The Effect of Distortions on Managerial Incentives and Competition in a Global Market

This thesis examines the impact of competition and international trade on managerial in- centives when there exist contractual distortions. The manager can decide to exert e¤ort on a cost-reducing or a non-contributory task, where the owner does not observe the total level of e¤ort and the distribution of e¤ort among both tasks. I show that when managerial e¤ort is imperfectly veri…able, the likelihood that trade-openness increases the degree of market competition, and consequently total consumer welfare, is higher than in the …rst-best situ- ation. When the degree of contractual distortions for a given industry is allowed to di¤er across countries, countries that experience the least amount of distortions are the most likely to bene…t from trade. Secondly, at the …rst-best level of e¤ort, over-incentivized managers cause the degree of market competition to decrease over time, which reduces the amount of available varieties in equilibrium. When …rms experience contractual distortions, this e¤ect is reduced. Less e¢ cient …rms are then able to survive in the market, which increases the degree of market competition and as a result the amount of available varieties and aggregate consumer welfare.