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Openness, managerial incentives, and heterogeneous firms

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Abstract

This paper examines the effects of trade openness on managerial incentives and firm-level productivity by incorporating the principal-agent mechanism into the heterogeneous firm trade framework inter alia Melitz (Econometrica 71:1695–1725, 2003). We show that opening up to trade generally leads to a steeper optimal managerial incentive scheme (and hence, higher firm productivity) via a new mechanism by which selection of heterogeneous firms into the export market plays a key role. This is because trade openness unambiguously increases the variation of firm profits by reallocating profits towards ex post low-cost exporters, leading to a higher stake of the market game faced by the principals. Interestingly, it is further shown that, whilst falling variable trade costs unambiguously increase managerial incentives, a reduction in fixed trade costs could possibly lead to weaker incentives and thus generate productivity losses due to an adverse inter-firm reallocation effect. Hence, the model establishes a causal link between the Melitz-type reallocation effect and the within-firm productivity changes, both of which have been identified as important sources of aggregate productivity gains from trade by recent empirical studies.

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Authors and Affiliations

  1. The Leverhulme Centre for Research on Globalisation and Economic Policy, School of Economics, Nottingham University, C4, Sir Clive Granger Building, University Park, Nottingham, NG72RD, UK

    Zhihong Yu

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  1. Zhihong Yu
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Correspondence to Zhihong Yu.

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The author would like to thank the editor, co-editor Tim Kehoe, two anonymous referees, Spiros Bougheas, Hongbin Cai, Carl Davidson, Rod Falvey, Arijit Mukherji, Jie Ma, Marc Melitz, Hitoshi Sato, and participants at the seminar of Michigan State University, Midwest International Economics Group Meeting Fall 2008 at Michigan University at Ann Arbor, the Annual Conference of Royal Economic Society 2008 at Warwick University, and the seminar of Guanghua School of Management, Peking University for helpful comments. I also thank the Research Council UK and The Leverhulme Trust for financial support under Programme Grant F/00 114/AM.

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Yu, Z. Openness, managerial incentives, and heterogeneous firms. Econ Theory 51, 71–104 (2012). https://doi.org/10.1007/s00199-010-0595-1

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