X-INEFFICIENCY, COMPETITION AND MARKET INFORMATION* Paolo Bertoletti and Clara Poletti Whether competition forces ¢rms toward e¤cient behaviour is an open question. We consider a duopoly with ¢rms run by managers and a¡ected by adverse selection on costs. In contrast to recent literature, we point out that, to have a genuine e¡ect on ¢rm X-ine¤ciency, competition must change managerial incentives. By introducing the availability of some signal on the rivals' behaviour we show that, if costs are correlated, the contractual use of that signal can render private managerial information unin£uential. This result stresses the informational role of the market and suggests scope for future work. i. introduction and motivation Whether competition forces ¢rms toward e¤cient behaviour is an old, but still open, question. The topic is certainly important: the view that competition promotes e¤ciency is widespread, and industrial policies have often been based on this presumption. However, the issues at stake are broad and their economic content is not unambiguously de¢ned. What kind of ine¤ciency is involved, and where does it come from? Which type of competition is invoked and how is an increase of competitive pressure measured? This paper questions the way recent theoretical literature (see Martin [1993], Stenbacka [1993], Horn, Lang and Lundgren [1994] and Panunzi [1994]) addresses these issues. That literature uses the theory of contracts under asymmetric information to provide a rationale for ¢rm productive ine¤ciency. An agent, interpreted as the ¢rm manager, exploits an informational advantage with respect to his principal, the ¢rm owner. The standard result is that the optimal contract distorts ¢rm activity away from e¤cient cost-minimising behaviour, i.e. asymmetric information ß Blackwell Publishers Ltd. 1997, 108 Cowley Road, Oxford OX4 1JF, UK, and 350 Main Street, Malden, MA 02148, USA. 359 THE JOURNAL OF INDUSTRIAL ECONOMICS 0022-1821 Volume XLV December 1997 No. 4 * We would like to thank Michele Grillo, Jonathan Haskel, Stephen Martin, two anonymous referees, and a member of the Editorial Board for helpful comments on earlier versions of this paper. We are indebted to Michael Waterson for many encouraging and valuable suggestions. Financial support from MURST is gratefully acknowledged. Errors are ours.