Price Authority under Competing Organizations

Abstract

This paper characterizes the degree of price discretion that competing organizations (principals) award to their sales managers (agents) and examines how such discretion is affected by principals' competitive conduct, market concentration, product substitutability, and demand volatility. We lay down a model in which firms sell differentiated products and sales managers own private information about demand and incur positive marketing costs to sell products to final consumers. Principals cannot internalize these costs through monetary incentives and need to design `permission sets' from which their representatives choose prices. The objective is to understand the forces shaping this set and the constraints (if any) imposed on equilibrium prices. We find that when principals behave non-cooperatively, sales managers are biased towards excessively high prices owing to their will to pass on marketing costs to consumers. Hence, in equilibrium, the permission set requires a list price that caps agents' pricing choices. Such list price is more likely to bind in less concentrated industries, when products are closer substitutes, in industries where distribution requires sufficiently high costs and demand is not too volatile. Instead, when principals behave cooperatively and maximize industry profit, the optimal delegation scheme is more complex. Because principals want to raise prices to the monopoly level, in this regime, the optimal permission features a price floor rather than a list price when the marketing cost is sufficiently low, it features instead full discretion for moderate values of this cost, and only when it is sufficiently high, a list price is optimal. Interestingly, while competition hinders delegation in the noncooperative regime, the opposite happens when principals maximize industry profit.