Moral Hazard, Mergers, and Market Power

Most analysis of market power assumes that managers are perfect agents for shareholders. This paper relaxes that assumption. When managers of a multiproduct firm exert unobservable effort to improve product quality, price coordination incentives tradeoff with 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 with some profit sharing, intra-firm price competition can be severe enough that quality adjusted price is lower under under common ownership