Moral Hazard, Mergers, and Market Power

Most analysis of market power assumes that managers act as perfect agents for the shareholders. This paper relaxes this assumption. When managers of a multiproduct firm must exert unobservalbe effort to improve product quality, there will be a tension between the optimal incentive scheme for eliminating price competition between the products and creating optimal effort incentives. This makes some intra-firm price competition inevitable. When quality improving effort generates positive spillovers, the optimal amount of price competition can be as great or greater than when the products are under separate ownership. Even when this is not the case, intra-firm price competition can be severe enough that quality adjusted price is lower when the products are under common ownership.