In oligopolies, firms behave strategically and commit to actions that elicit favorable responses from rivals. Firm actions consequently are a function of the nature of these strategic interactions. In this paper, we develop a methodology for the empirical estimation of strategic interactions in product markets. We then apply our measure of strategic interactions to CEO compensation. We use quarterly data on profits and sales from Compustat to estimate the slope of firm’s reaction function. When the slope is negative and marginal profits decrease with an increase in the rival’s actions the firm is classified as a strategic substitute. When the slope is positive and marginal profits increase with an increase in the rival’s actions the firm is classified as a strategic complement. As predicted by theory, we find significant evidence that strategic substitutes decrease the pay for performance incentives of their CEOs. On the other hand, strategic complements significantly increase CEO pay for performance incentives. The empirical measure developed can be used to test a wide variety of strategic models.

This paper examines the effect of CEO compensation contracts on misreporting. We find that the sensitivity of the CEO's option portfolio to stock price is significantly positively related to the propensity to misreport. We do not find that the sensitivity of other components of CEO compensation, i.e., equity, restricted stock, long-term incentive payouts, and salary plus bonus have any significant impact on the propensity to misreport. Relative to other components of compensation, stock options are associated with stronger incentives to misreport because convexity in CEO wealth introduced by stock options limits the downside risk on detection of the misreporting.