On the Impact of Managerial Bonus Systems on Firm Profit and Market Competition: The Cases of Pure Profit, Sales, Market Share and Relative Profits Compared

By designing remuneration schemes based on a bonus rewarding specific firm-level outcomes, the owners/shareholders of a firm can manipulate the behavior of their managers. In practice, different bonus anchors take center stage: some are profit-based, others use sales as the key yardstick and still different ones focus on relative performance vis-a'-vis a peer group. In this paper, we focus on the impact of remuneration schemes on firm-level profitability. The profit effect is investigated for (all possible combinations of) four bonus systems using delegation games. In the context of a linear Cournot model for two or three firms, we model a two- or three-stage decision structure where, in the first stage (or first two stages), an owner decides on the bonus system for his manager and where, in the final stage, the manager takes the daily output decision for her firm. It appears that the bonus system based on relative (profits) performance is superior throughout. Copyright (C) 2008 John Wiley & Sons, Ltd.