On the design of managerial incentives for sustainability investments in the presence of competitors

Jasper Veldman*, Gerard Gaalman

*Corresponding author for this work

Research output: Contribution to journalArticleAcademicpeer-review

1 Citation (Scopus)

Abstract

In many industries, an increasing number of firm owners tie managers’ incentives to sustainability investments. Positive rewards directly increase a manager's total pay when that manager makes sustainability investments, whereas negative rewards directly decrease a manager's pay when those investments are made. Strategic incentive design literature posits that such organizational choices also affect the decisions of a firm's competitors. This paper uses a game-theoretic framework to analyze the effects of sustainability incentives in a setting with two competing firms. In contrast to the existing literature, in the current paper sustainability investments have a demand-enhancing effect and can increase or decrease the unit cost of production, making the current framework more in line with industrial practice. The results show that a firm invests in sustainability only if the demand-enhancing effects outweigh the cost-increasing effects. More importantly, positively rewarding managers for sustainability investments is done in equilibrium only if the innovation capability of the firm is sufficiently high. However, in terms of profits, those positive rewards lead to a prisoner's dilemma. When innovation capability is lower, firm owners use negative rewards and raise their profits. Another finding is that rival firms that cooperate in determining their sustainability incentives increase their profits but do so using negative rewards. These results, which have not been reported in the literature, point to some critical trade-offs in terms of sustainability investments and firm profits when sustainability incentives are considered and are both managerially and academically relevant.

Original languageEnglish
Article number120925
Number of pages11
JournalJournal of Cleaner Production
Volume258
DOIs
Publication statusPublished - 10-Jun-2020

Keywords

  • Strategic incentive design
  • Managerial incentives
  • Sustainability
  • Investment
  • Game theory
  • RESEARCH-AND-DEVELOPMENT
  • PROCESS IMPROVEMENT
  • SUPPLY CHAIN
  • COMPENSATION
  • PERFORMANCE
  • OLIGOPOLY

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