Why Do Socially Concerned Firms Provide Low-powered Incentives to Their Managers?
Abstract: We introduce a mixed quantity-setting duopoly with a socially concerned firm and a profit-maximizing firm. Both firms can either hire a selfish manager solely interested in monetary compensation or an intrinsically motivated manager who is also partially interested in the goal of the firm. We derive the optimal combination of the organization's type and the organization's managerial compensation structure. Although both firms prefer to hire an intrinsically motivated manager to save on compensation costs, we find that the structure of the compensation system offered to the manager depends on the firm's strategic orientation. In equilibrium, the profit-maximizing firm uses a high-powered (strategic) incentive contract based on profit and sales revenue. In contrast and in line with empirical evidence, the socially concerned firm uses a straight salary to compensate its manager. We further discuss the endogenous choice of social strategy and demonstrate that in a strategic setting it is optimal for profit-maximizing investors to consider the welfare of consumers. In summary, we provide a further justification for the recent increase of social responsibility as a competitive strategy and the widespread use of low-powered incentives in socially concerned firms.
