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Market share objectives are prominent in many industries, especially where managers pay much attention to league table rankings. This paper explores the strategic rationale for giving managers incentives based on market share, motivated by evidence from executive compensation practice in the automotive and investment banking industries. Strategic incentives for market share dominate the well-known sales revenue contracts analyzed in much of the literature, but perhaps surprisingly also lead to less competitive outcomes. The more general lesson is that, when competing in strategic substitutes, players will wish to commit to aggressive conduct, but also make their behaviour less manipulable by rivals.

Market share objectives are prominent in many industries. Countless press reports, mission statements and interviews with corporate executives reveal that managers place significant emphasis on their firm's market share. At the same time market share objectives are a sign of aggressive competition. This is particularly apparent in the automotive industry where buyer discount programs have for years been squeezing the profitability of major producers, perhaps most notably General Motors. Indeed, The Economist concludes a recent survey on the industry by noting that “car firms must reinvent themselves to seek profit, not just market share”.1 This paper shows that strategic considerations provide a rationale for giving managers incentives based on market share. It also discusses empirical evidence on executive compensation practice in the automotive and the investment banking industries. In both of these, as predicted by the theory, firms use explicit contractual incentives related to market share. Therefore, the attention paid by managers in these industries to so-called league table rankings—which are based on market share, not profits—can be understood as a natural corollary of the incentive structure. The strategic value of commitment to non-profit maximizing objectives was first recognized by Schelling (1960). This idea was introduced into the industrial organization literature in seminal papers by Vickers (1985), Fershtman and Judd (1987) and Sklivas (1987). These papers find that, when competing in strategic substitutes, owners wish to delegate decision-making to managers who are given aggressive sales incentives. Firms end up in a prisoners' dilemma as a result.2 This has implications for a wide range of issues in industrial organization, including collusion (e.g., Lambertini and Trombetta, 2002), patent licensing (e.g., Saracho, 2002) and mergers (e.g., Ziss, 2001). Motivated by the empirical evidence, the present analysis aims to clarify the implications of strategic incentives for market share. These are shown to dominate the well-known sales revenue (and output-based) contracts analyzed in much of the literature—as well as simple profit maximization. Moreover, and perhaps surprisingly, the incentive equilibrium with market share contracts turns out to be less competitive than under the other contracts—despite the inherent relative performance component. Players remain in a prisoners' dilemma, but in a less severe one. The more general lesson from the model is that managerial incentive contracts have two roles in strategic settings. The first is very well-known: Contracts constitute a commitment to making managerial behaviour more aggressive. The second is largely neglected in the literature: Contracts can make managerial behaviour less susceptible to strategic manipulation by rivals. Contracts observed in practice are rich enough to assume both of these roles. The remainder of the paper is organized as follows. Section 2 discusses empirical evidence for executive compensation based on market share. Section 3 describes the benchmark Cournot model that is used to explore the strategic advantages associated with market share incentives. Section 4 presents the results from the model and provides further discussion and extensions. Section 5 concludes. The Appendix contains detailed derivations for proofs omitted from the main text for expositional continuity.

Committing to market share contracts dominates the well-known sales revenue and output-based contracts — as well as simple profit maximization — in an oligopoly competing in strategic substitutes. This provides a strategic rationale for the prominence of market share objectives in current executive compensation practice in the automotive and investment banking industries. The analysis thus sheds some light on the interplay between contracts and competition in industries where managers pay much attention to league table rankings. In contrast to a well-known principle from incentive theo- ry, see Kerr (1975) , “ the folly of rewarding A — market share — while hoping for B — profits ” may in fact be a “ necessary evil ” . This might also help explain why The Economist's call for car firms to “ reinvent themselves to seek only profit ” is proving to be somewhat difficult to realize. Giving managers incentives for market share is an aggressive but moreover also a “ robust ” strategy, as it makes managerial behaviour less susceptible to strategic manipulation by rivals. This latter property has not been emphasized in the literature and sets market share apart from other measures of firm size. Relatedly, and perhaps surprisingly, the incentive equilibrium with market share contracts is in fact less competitive. The gains to con- sumers from firms' market share objectives are substan- tial,butneverthelesslowerthanmighthavebeenexpected. Indeed, it is clear that this basic intuition holds far more generally. When competing in strategic substitutes, players will wish to commit to aggressive conduct, but also make their behaviour less manipulable by rivals. This reduces the degree of interdependence and hence the temptation to be aggressive in the first place. Players remain in a prisoners' dilemma, but in a less severe oneThese theoretical predictions would also lend themselves naturally to testing in experimental markets.