Managerial contract duration, cartel stability and pricing dynamics

Résumé

This paper argues that commonly observed fixed-term renewable employment contracts may increase cartel stability. When managerial appointments are renewed if and only if the firm performs well, cartel stability depends not only on (i) the conventional tradeoff between the immediate monetary gain of defection and the future monetary losses of punishment, but also on (ii) the tradeoff between the immediate decrease in the probability of being fired (due to superior firm performance during defection) and the future increase in probability of being fired (due to inferior firm performance during punishment). If the latter effect dominates, short-term managerial contracts stabilise cartels. A testable implication of the model is that price wars occur towards the end of a manager's appointment when firm performance has been bad, followed either by (i) firing the manager and cartel breakdown, or (ii) reappointing the manager and cartel revival when current firm performance turns out to be good.