Organizational Design and the Intensity of Rivalry

We analyze the effect of managerial compensation schemes and organizational structure on competitive behavior in imperfectly competitive product markets. Previous research suggests that, in cases of strategic substitutability, firms tend to choose organizational structures and compensation systems that commit the firm to behave aggressively in the product market, reducing firm and industry profits. In contrast, we show that, while compensation and structure in isolation lead to excessive aggressiveness, the combination of these two internal choice variables may reverse the outcome and remove the typical prisoner’s dilemma. As a result, we demonstrate that organizational design can be used as a commitment device to reduce competitive rivalry. Finally, we find that, in equilibrium, firms may choose to be different: one firm is decentralized and uses aggressive incentives, while the other is centralized and uses cooperative incentives. Hence, endogenous firm heterogeneity in the form of organizational differentiation allows firms to avoid a mutually detrimental outcome. ∗The author would like to thank Jonghoon Bae, Neil Brisley, Ramon Casadesus-Masanell, Karel Cool, James Dana, Laurens Debo, Nicola Dragonetti, Javier Gimeno, Bruce Kogut, William Rogerson, Vicente Salas-Fumas, Daniel Spulber, Tim Van Zandt, Xavier Vives, Keith Weigelt, and Peter Zemsky for valuable comments, while retaining full responsibility for the final product. The author especially thanks Francisco Ruiz-Aliseda for his input in several of the initial discussions.