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Relative Performance Evaluation and Contract Externalities

Authors/Editors: Asseburg, Holger
Hofmann, Christian
Published: 2009
Type: Articles in Refereed Journals (International)
ISBN/ISSN: 0171-6468
Published by: OR Spectrum
Additional information: 32 (1) 2009, 1-20


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.