Product Market Competition and Agency Costs

by Jen Baggs and Jean-Étienne de Bettignies
Business and Labour Market Analysis Division
Analytical Studies Branch Research Paper Series, No. 287

Context

Economists have long held the belief that competition improves efficiency. One of the mechanisms suggested is that product market competition alleviates agency costs, which in turn may enable firms to induce higher effort and greater efficiency from their managers. Despite growing interest, an unambiguous theoretical formulation has proved difficult to obtain.

Objective(s)

This paper examines theoretically and empirically the effects of product market competition on agency costs.

Findings

Product market competition, by reducing agency costs, unambiguously increases the importance firms place on quality improvements. This leads to higher powered incentives, and in turn to increased effort and quality. These effects are increasing in the severity of agency problems, and should be stronger in large, hierarchical corporations (where agency problems are more severe) than in entrepreneurial firms. The study tests the predictions of the model developed using a unique dataset with both firm and employee characteristics.

Data source(s)

The study uses the data of the Workplace and Employee Survey (WES).

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