Bargaining, Profit-Sharing and Irreversible Investment Decisions In An Oligopoly

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Bargaining, Profit-Sharing and

Irreversible Investment

Decisions In An Oligopoly

Jyh-bang Jou

National Taiwan University Tan Lee

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Abstract

This article considers a firm in an oligopoly as a

quasi-permanent organization of shareholders and employees. The firm undertakes incremental investment and the investment expenditures are fully sunk. The firm’s employees receive a fixed wage rate as well as share a portion of the firm’s profits. The profit-sharing rate is determined by the firm’s manager, who finds a cooperative game solution through mediating between the shareholders and employees. The firm’s manager will grant a lower profit-sharing rate to the employees and will install a smaller capacity when facing more competitors. However, the choice of capacity for the industry as a whole will increase as

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I. Literature Review

 Weitzman (1983,1985): Argue that profit-shari

ng schemes might affect labor productivity, t he unemployment rate, and wage rate.

 _{Aoki (1980): The relative bargaining power b}

etween shareholders and employees affects t he distribution of profits between them.

 _{Moretto and Rossini (1995): The shut-down o}

ption as well as the relative bargaining powe r between shareholders and employees affec t distribution of the firm’s profits.

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II. The purpose of This Article

a.

How does competitive pressure

affect investment incentives?

Answer: Given a firm’s profit-sharing rate, increasing competition induces a firm to invest later.

This is just opposite to Grenadier’s finding (2002).

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Why does this divergence arise?

Answer: This article allows capital and labor to be substitutable each other, while Grenadier assumes that capital, the only input, produces output corresponding to a one-to-one relationship.

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b.

How does competitive pressure

affect the profit-sharing rate?

Answer: A firm facing more competitors will grant a lower share of profits to its employees.

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Why does this happen?

Answer: Employees not only receive a fixed wage rate that is determined by the external labor market, but also receive a bonus out of the firm’s profits. However, a firm’s profits will be lower as more firms exist in the industry. Increasing competition thus exerts more harm on shareholders than on employees because the pie that shareholders can share shrinks. Consequently, as a mediator, the firm’s manager must grant a larger share to its shareholders, or equivalently, a lower share to its employees when facing more competitors.

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III. Basic Assumptions

a. An industry that is composed of N

identical firms.

b. Each firm employs Cobb-Douglas

technology with labor and capital as its inputs.

c. Constant-elastic demand function whose

multiplicative demand-shift factor following geometric Brownian motion.

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IV. Solution Procedures and The

Main Findings

(i)

Solving the short-run output

decision made by the firm’s

manager who acts on behalf of

shareholders.

The portion of the firm’s profits

to its shareholders and total

compensation for the firm’s

employees are then derived.

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(ii)

Solving the long-run investment

decision made by a firm’s

manager.

The firm’s net value to its

shareholders and the firm’s net

value to its employees are then

derived.

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Proposition 1:

(a) Given the capital stock for the

industry as a whole, a firm will invest

later when facing more competitors.

(b) Given an individual firm’s stock of

capital, the firm will invest later when

facing more competitors.

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Proposition 2:

A firm’s desired

capital stock will be lower if

(a) the profit-sharing rate attributed to

employees is higher,

(b) competition becomes more intense,

and

(c) demand uncertainty is more

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Corollary 1:

As compared to a firm

that does not employ any

profit-sharing plans, a firm that optimally

chooses its profit-sharing schemes

will install a smaller capacity.

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(iii)

A representative employee will

bargain for the profit-sharing rate

with the manager immediately

before

the

manager

makes

investment decisions.

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Proposition 3:

A firm’s manager will

grant a lower profit-sharing rate to

employees as

(a) the firm faces more competitors,

(b) the firm’s employees have a relatively

lower bargaining power,

(c) the price elasticity of demand is larger,

and

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Proposition 4:

The profit-sharing

premium,

i.e.,

profit-sharing

bonuses

over

total

wage

payment, is lower as competition

becomes more intense.

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Proposition 5:

(a) As the bargaining power of employees is

decreasing relative to that of shareholders, a firm’s optimal capacity will increase.

(b) As competitive pressure increases, a firm’s

choice of capital stock will decrease, yet the desired capital stock for the industry as a whole will decrease.