Openness, managerial incentives, and heterogeneous firms

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.

This is a preview of subscription content, access via your institution.

References

  1. Antras P.: Firms, contracts and trade structure. Q J Econ 118, 1375–1418 (2003)

    Article  Google Scholar 

  2. Antras P., Helpman E.: Global sourcing. J Polit Econ 112, 552–580 (2004)

    Article  Google Scholar 

  3. Antras P., Rossi-Hansberg E.: Organizations and trade. Annu Rev Econom 1, 43–64 (2009)

    Article  Google Scholar 

  4. Atkeson A., Burstein A.: Innovation, firm dynamics, and international trade. J Polit Econ 118, 433–484 (2010)

    Article  Google Scholar 

  5. Baldwin R., Forslid R.: Trade liberalisation with heterogeneous firms. Rev Dev Econ 14(2), 161–176 (2010)

    Article  Google Scholar 

  6. Bandiera O., Barankay I., Rasul I.: Incentives for managers and inequality among workers:evidence from a firm-level experiment. Q J Econ 122, 729–773 (2007)

    Article  Google Scholar 

  7. Bernard A., Jensen B.: Exceptional exporter performance: cause, effect, or both?. J Int Econ 47, 1–25 (1999)

    Article  Google Scholar 

  8. Bernard A.B., Jensen J.B., Schott P.K.: Trade costs, firms and productivity. J Monet Econ 53, 917–937 (2006)

    Article  Google Scholar 

  9. Bernard A.B., Eaton J., Jensen J.B., Kortum S.: Plants and productivity in international trade. Am Econ Rev 93, 1268–1290 (2003)

    Article  Google Scholar 

  10. Bernard A.B., Redding S.J., Schott P.K.: Comparative advantage and heterogeneous firms. Rev Econ Stud 74, 31–66 (2007)

    Article  Google Scholar 

  11. Bloom N., Van Reenen J.: Measuring and explaining management practices across firms and countries. Q J Econ 122, 1351–1408 (2007)

    Article  Google Scholar 

  12. Bustos, P.: Trade liberalization, exports and technology upgrading: evidence on the impact of MERCOSUR on Argentinean firms. Am Econ Rev (forthcoming)

  13. Clerides S., Lach S., Tybout J.: Is ‘learning-by-exporting’ important?. Q J Econ CXIII, 903–948 (1998)

    Article  Google Scholar 

  14. Costantini J., Melitz M.: The dynamics of firm level adjustment to trade iberalization. In: Helpman, E., Marin, D., Verdier, T. (eds) The Organization of Firms in a Global Economy, pp. 107–141. Harvard University Press, Cambridge MA (2008)

    Google Scholar 

  15. Davidson C., Matusz S., Shevchenko A.: Globalization and firm level adjustment with imperfect labor markets. J Int Econ 75(2), 295–390 (2008)

    Article  Google Scholar 

  16. Ederington J., McCalman P.: Endogenous firm heterogeneity and the dynamics of trade liberalization. J Int Econ 74, 422–440 (2008)

    Article  Google Scholar 

  17. Falvey, R., Greenaway, D., Yu, Z.: Extending the melitz model to asymmetric countries. GEP research paper series 06/07 (2006)

  18. Grossman G., Helpman E.: Managerial incentives and managerial incentives and the international organization of production. J Int Econ 63, 237–262 (2004)

    Article  Google Scholar 

  19. Hart O.: The market as an incentive mechanism. Bell J Econ 14, 366–382 (1983)

    Article  Google Scholar 

  20. Horn H., Lang H., Lundgren S.: Managerial effort incentives, X-inefficiency and international trade. Eur Econ Rev 39, 117–138 (1995)

    Article  Google Scholar 

  21. Karuna C.: Industry product market competition and managerial incentives. J Account Econ 43, 275–297 (2007)

    Article  Google Scholar 

  22. Krugman P.: Increasing returns, monopolistic competition, and international trade. J Int Econ 9, 469–479 (1979)

    Article  Google Scholar 

  23. Krugman P.: Scale economies, product differentiation, and the pattern of trade. Am Econ Rev 70, 950–959 (1980)

    Google Scholar 

  24. Lai E., Riezman R., Wang P.: Outsourcing of innovation. Econ Theory 38, 485–515 (2009)

    Article  Google Scholar 

  25. Melitz M.J.: The impact of trade on intra-industry reallocations and aggregate industry productivity. Econometrica 71, 1695–1725 (2003)

    Article  Google Scholar 

  26. Naghavi A., Ottaviano G.: Offshoring and product innovation. Econ Theory 38, 517–532 (2009)

    Article  Google Scholar 

  27. Nickell S.: Competition and corporate performance. J Polit Econ 104, 724–746 (1996)

    Article  Google Scholar 

  28. Okada, Y.: Competition and Productivity in Japanese Manufacturing Industries, NBER working paper W11540 (2005)

  29. Okubo T.: Firm heterogeneity and ricardian comparative advantage within and across sectors. Econ Theory 38, 533–559 (2009)

    Article  Google Scholar 

  30. Pavcnick N.: Trade liberalization, exit, and productivity improvements:evidence from chilean plants. Rev Econ Stud 69, 245–276 (2002)

    Article  Google Scholar 

  31. Raith M.: Competition, risk and managerial incentives. Am Econ Rev 93, 1425–1436 (2003)

    Article  Google Scholar 

  32. Roberts M., Tybout J.: The decision to export in columbia:an empirical model of entry with sunk costs. Am Econ Rev 87, 545–564 (1997)

    Google Scholar 

  33. Scharfstein D.: Product-market competition and managerial slack. RAND J Econ 19, 147–155 (1988)

    Article  Google Scholar 

  34. Schmidt K.M.: Managerial incentives and product market competition. Rev Econ Stud 64, 191–213 (1997)

    Article  Google Scholar 

  35. Trindade, V.: Openness and productivity: a model of trade and firm-owners’ Effort. Mimeo (2008)

  36. Van Long, N., Raff, H., Stähler, F.: Innovation and Trade with Heterogeneous Firms, Kiel Working Papers 1430, Kiel Institute for the World Economy (2008)

Download references

Author information

Affiliations

Authors

Corresponding author

Correspondence to Zhihong Yu.

Additional information

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.

Rights and permissions

Reprints and Permissions

About this article

Cite this article

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

Download citation

Keywords

  • Openness
  • Managerial incentives
  • Heterogeneous firms
  • Productivity

JEL Classification

  • F12
  • F13
  • L25