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Relative performance evaluation and contract externalities

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Abstract

We consider the incentive characteristics of optimal linear contracts based on relative performance evaluation (RPE) for managers under moral hazard in imperfectly competitive product markets. Each contract influences the quantity choices of all competing agents causing contract externalities that affect the principals’ contracting game. We analyze the relations between the optimal extent of RPE and several firm and market characteristics, allowing for heterogeneous firms and idiosyncratic firm risk. In general, we find non-monotonic comparative static results regarding the influence of market and firm-specific risk, the industry’s competitiveness, and the correlation of the firms’ profit.

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Authors and Affiliations

  1. University of Tübingen, Nauklerstr. 47, 72074, Tübingen, Germany

    Holger Asseburg

  2. Department of Business Administration and Managerial Accounting, University of Mannheim, 68131, Mannheim, Germany

    Christian Hofmann

Authors
  1. Holger Asseburg
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  2. Christian Hofmann
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Correspondence to Christian Hofmann.

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Asseburg, H., Hofmann, C. Relative performance evaluation and contract externalities. OR Spectrum 32, 1–20 (2010). https://doi.org/10.1007/s00291-008-0132-9

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  • DOI: https://doi.org/10.1007/s00291-008-0132-9

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