Investment Choice with Managerial Incentive Schemes

Abstract

In this paper, we show that firms might get an additional strategic benefit from using marginal-cost-reducing investments in conjunction with strategic delegation. While both these instruments allow firms to “aggressively” participate in product market competition, we show that they act as substitutes or complements depending on whether they are chosen simultaneously or sequentially. Given that the use of such instruments is inseparably linked with a Prisoner’s Dilemma kind of situation, our analysis shows a way to mitigate at least to some extent such effects, through their simultaneous use. We find that the unique Nash equilibrium of the game with commitment comprises both players choosing the instruments simultaneously. In case the instruments are chosen without commitment, an asymmetric equilibrium is shown to exist in addition to the simultaneous protocol, yielding unequal payoffs.