The impact of business objectives and the time horizon of performance evaluation on pricing behavior

Abstract

There is an emerging literature that focuses on (excessive) patterns in competitive behavior based on the nature of company objectives, reward systems, organizational structures and information systems for managers. We consider questions related to this area of inquiry in a setting in which managers make pricing decisions over time. We manipulate the nature of objectives the managers are instructed to pursue and the frequency with which they are told their performance will be evaluated. We find that a long time horizon (reduced frequency of evaluation) results in managers engaging in more price experimentation, presumably to learn the demand function, and in reduced competitive reactivity, compared with a shorter horizon. If the objective is "do the best you can", managers tend to pursue relative performance objectives. This pursuit tends to result in higher competitive reaction effects, compared with "profit maximization". In the experiment, the combination of a long time horizon and profit maximization as the objective produces highest average profits. Our results suggest that firms may want to reconsider the formulation of objectives and the time horizon of performance evaluation systems.