Managerial incentives and financial signaling in product market competition

Abstract

This paper demonstrates how management compensation schemes can serve as an inexpensive and sometimes even free signaling mechanism. In the particular example studied here it is shown how a contract offered to the manager of a monopolistic firm may induce him to take some actions that will credibly signal the firm's marginal cost and will deter entry if the firm is `sufficiently' efficient. This signaling mechanism is not costly to the monopolist and therefore, it may prefer this mechanism to the costlier `limit pricing' one.