Estimating product market competition: Methodology and application |
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| Affiliation: | 1. The Wharton School, University of Pennsylvania, 1300 Steinberg-Dietrich Hall, Philadelphia, PA 19104-6365, United States;2. Tuck School of Business, Dartmouth College, 100 Tuck Hall, Hanover, NH 03755, United States;3. Carroll School of Management, Boston College, 140 Commonwealth Ave., Chestnut Hill, MA 02467, United States;1. College of Business Administration, University of Texas at El Paso, 500 West University Avenue, El Paso, TX, 79968, USA;2. Stern School of Business, New York University, 44 West 4th Street, New York, NY, 10012, USA;1. Harvard Business School, Boston, Massachusetts, United States;2. Penn State University, Pennsylvania, United States;3. Massachusetts Institute of Technology, Massachusetts, United States;1. Department of Money and Banking, College of Commerce, National Chengchi University, Taiwan;2. Department of Finance, College of Business, Chung Yuan Christian University, Taiwan;3. Department of Finance, College of Commerce, National Chengchi University, Taiwan;4. Risk and Insurance Research Center, College of Commerce, National Chengchi University, Taiwan |
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| Abstract: | In oligopolies, firms behave strategically and commit to actions that elicit favorable responses from rivals. Firm actions consequently are a function of the nature of these strategic interactions. In this paper, we develop a methodology for the empirical estimation of strategic interactions in product markets. We then apply our measure of strategic interactions to CEO compensation. We use quarterly data on profits and sales from Compustat to estimate the slope of firm’s reaction function. When the slope is negative and marginal profits decrease with an increase in the rival’s actions the firm is classified as a strategic substitute. When the slope is positive and marginal profits increase with an increase in the rival’s actions the firm is classified as a strategic complement. As predicted by theory, we find significant evidence that strategic substitutes decrease the pay for performance incentives of their CEOs. On the other hand, strategic complements significantly increase CEO pay for performance incentives. The empirical measure developed can be used to test a wide variety of strategic models. |
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