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Impact of financial constraint on incentive compensation and product market behavior

Author

Listed:
  • Jaideep Chowdhury

    (James Madison University)

Abstract

This paper introduces financing constraint in a model of incentive compensation and product market and develops key insights about the interactions of product market behavior, financial constraint and incentive compensation. A financially constrained firm faces higher cost of capital which results in lower output. The model suggests that a financially constrained firm offers higher incentive compensation to its manager if the degree of product differentiation is sufficiently low. This higher incentive encourages the manager to put more effort and produce more output in order to compensate for the loss in output due to financial constraint. Our paper generates the testable hypothesis that a financially constrained firm will offer higher incentive compensation to its manager which has not yet been tested empirically.

Suggested Citation

  • Jaideep Chowdhury, 2014. "Impact of financial constraint on incentive compensation and product market behavior," Economics Bulletin, AccessEcon, vol. 34(1), pages 115-124.
    • Handle: RePEc:ebl:ecbull:eb-13-00796
    as

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    File URL: http://www.accessecon.com/Pubs/EB/2014/Volume34/EB-14-V34-I1-P13.pdf
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    References listed on IDEAS

    as
    1. Cécile Aubert, 2008. "Managerial effort incentives and market collusion," Post-Print hal-00382224, HAL.
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    3. Lucian Bebchuk, 2005. "The Growth of Executive Pay," Oxford Review of Economic Policy, Oxford University Press and Oxford Review of Economic Policy Limited, vol. 21(2), pages 283-303, Summer.
    4. Reitman, David, 1993. "Stock Options and the Strategic Use of Managerial Incentives," American Economic Review, American Economic Association, vol. 83(3), pages 513-524, June.
    5. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(4), pages 391-405, December.
    6. Povel, Paul & Raith, Michael, 2004. "Financial constraints and product market competition: ex ante vs. ex post incentives," International Journal of Industrial Organization, Elsevier, vol. 22(7), pages 917-949, September.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Product Differentiation; Financial Constraints; Executive Compensation;
    All these keywords.

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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