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
• Yuan Ze University

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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 firms
  employees receive a fixed wage rate as well as
  share a portion of the firms profits. The
  profit-sharing rate is determined by the firms
  manager, who finds a cooperative game solution
  through mediating between the shareholders and
  employees. The firms 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
  competition becomes more intense.

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I. Literature Review

• Weitzman (1983,1985) Argue that profit-sharing
  schemes might affect labor productivity, the
  unemployment rate, and wage rate.
• Aoki (1980) The relative bargaining power
  between shareholders and employees affects the
  distribution of profits between them.
• Moretto and Rossini (1995) The shut-down option
  as well as the relative bargaining power between
  shareholders and employees affect distribution of
  the firms profits.

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II. The purpose of This Article

• How does competitive pressure affect investment
  incentives?
• Answer Given a firms profit-sharing rate,
  increasing competition induces a firm to invest
  later.
• This is just opposite to Grenadiers 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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• 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
  firms profits. However, a firms 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 firms 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

• An industry that is composed of N identical
  firms.
• Each firm employs Cobb-Douglas technology with
  labor and capital as its inputs.
• Constant-elastic demand function whose
  multiplicative demand-shift factor following
  geometric Brownian motion.
• Shareholders and Employees share the firms
  profits.

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IV. Solution Procedures and The Main
Findings

• Solving the short-run output decision made by the
  firms manager who acts on behalf of
  shareholders.
• The portion of the firms profits to its
  shareholders and total compensation for the
  firms employees are then derived.

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• Solving the long-run investment decision made by
  a firms manager.
• The firms net value to its shareholders
  and the firms 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 firms stock of capital,
  the firm will invest later when facing more
  competitors.

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• Proposition 2 A firms 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 significant.

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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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• 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 firms manager will grant a
  lower profit-sharing rate to employees as
• (a) the firm faces more competitors,
• (b) the firms employees have a relatively lower
  bargaining power,
• (c) the price elasticity of demand is larger, and
  
• (d) the output elasticity of labor is higher.

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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
  firms optimal capacity will increase.
• (b) As competitive pressure increases, a firms
  choice of capital stock will decrease, yet the
  desired capital stock for the industry as a whole
  will decrease.

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V. Conclusion

• The main results shown by Propositions 1-5 can be
  empirically tested for future study.
• It is possible to construct a model that allows a
  firm to resell its installed capital stock.
• It is possible to allow other parameters to vary
  over time.
• It is possible to consider two types of
  employees, senior and junior ones as indicated by
  Aoki (1982).