Cartel Stability under Capacity Constraints: The Traditional View Restored

The existence of a negative relationship between cartel stability and the level of excess capacity in an industry has for a long time been the dominant view in the traditional IO literature. Recent supergame-theoretic contributions (e.g. Brock and Scheinkman, 1985) appear to show that this view is ill-founded. Focussing on the issue of enforcement of cartel rules ('incentive contraints'), however, this literature completely ignores firms' 'participation constraints'. Reverting the focus of attention, the present paper restores the traditional view: large cartels will not be sustainable in periods of high excess capacity (low demand). In contrast to the supergame-theoretic literature, it predicts a negative relationship between excess capacity and the collusive price.Collusion, excess capacity, business cycle, cartel stability

A Gap for Me: Entrepreneurs and Entry

We present a theory of entrepreneurial entry and exit decisions. Knowing their own managerial talent, entrepreneurs decide which market to enter, where markets differ in size. We obtain a striking sorting result: each entrant in a large market is more efficient than any entrepreneur in a smaller market since competition is endogenously more intense in larger markets. This result continues to hold when entrepreneurs can export their output to other markets, thereby incurring a unit transport cost or tariff. The sorting and price competition effects imply that the number of entrants (and hence product variety) may actually be smaller in larger markets. In the stochastic dynamic extension of the model, we show that the churning rate of entrepreneurs is higher in larger markets.entrepreneurship, entry, exit, firm turnover, industry dynamics

Underinvestment and Market Structure

This paper analyses a dynamic game of investment in R&D or advertising, where current investments change future market conditions. It investigates whether underinvestment can be supported in equilibrium by the threat of escalation in investment outlays. When there are no spillovers, or there is full patent protection, underinvestment equilibria are shown to exist even though, by deviating, a firm can get a persistent strategic advantage. When there are strong spillovers and weak patent protection, underinvestment equilibria fail to exist. This implies that weaker patent protection can actually lead to more investment in equilibrium. Furthermore, potential entry is introduced into the model so as to address the issues of market structure. It is shown that underinvestment equilibria can be stable with respect to further entry, independently of market size and entry costs. Finally, the 'nonfragmentation' result of static stage games is proved to hold in this dynamic game.Dynamic games, investment, collusion, industry structure

Globalization and Endogenous Firm Scope

We develop a theory of multiproduct firms to analyze the effects of globalization on the distributions of firm size, scope, and productivity. Our model explains two puzzles. First, it explains the well-known size-discount puzzle: large firms have lower values of Tobin%u2019s Q than small firms. Second, it explains the globalization-skewness puzzle documented in the empirical part of our paper: a multilateral reduction in trade costs leads to a flattening of the size distribution of firms. In our model, globalization not only affects the distribution of observed productivities but also productivity at the firm level.

An Assignment Theory of Foreign Direct Investment

Foreign Direct Investment, Mergers, Greenfield, Firm Heterogeneity

Do Vertical Mergers Facilitate Upstream Collusion? Second Version

We investigate the impact of vertical mergers on upstream firms' ability to sustain tacit collusion in a repeated game. We identify several effects and show that the net effect of vertical integration is to facilitate collusion. Most importantly, vertical mergers facilitate collusion through the operation of an outlets effect: cheating unintegrated firms can no longer profitably sell to the downstream affiliates of their integrated rivals. However, vertical integration also gives rise to an opposing punishment effect: it is typically more difficult to punish an integrated structure, so that integrated firms are able to make more profits in the punishment phase than unintegrated upstream firms. When downstream firms can condition their prices or quantities on upstream firms' contract offers, two additional effects arise, both of which further facilitate upstream collusion. First, an unintegrated upstream firm's deviation profits are reduced by the reaction effect which arises since the downstream unit of the integrated firm will now react aggressively to upstream deviations. Second, an integrated firm's deviation profit is reduced by the lack-of-commitment effect as it cannot commit to its own downstream price when deviating upstream.vertical merger, collusion, vertical restraint, vertical integration, repeated game, penal code

Globalization and Endogenous Firm Scope

We develop a theory of multiproduct firms to analyze the effects of globalization on the distributions of firm size, scope, and productivity. Our model explains two puzzles. First, it explains the well-known size-discount puzzle: large firms have lower values of Tobin’s Q than small firms. Second, it explains the globalization-skewness puzzle documented in the empirical part of our paper: a multilateral reduction in trade costs leads to a flattening of the size distribution of firms. In our model, globalization not only affects the distribution of observed productivities but also productivity at the firm level.multiproduct firms, firm size distribution, trade liberalization, size discount, firm heterogeneity, productivity

An Assignment Theory of Foreign Direct Investment

We develop an assignment theory to analyze the volume and composition of foreign direct investment (FDI). Firms conduct FDI by either engaging in greenfield investment or in cross-border acquisitions. Cross-border acquisitions involve firms trading heterogeneous corporate assets to exploit complementarities, while greenfield FDI involves building a new plant in the foreign market. In equilibrium, greenfield FDI and cross-border acquisitions co-exist, but the composition of FDI between these modes varies with firm and country characteristics. Firms engaging in greenfield investment are systematically more efficient than those engaging in cross-border acquisitions. Furthermore, most FDI takes the form of cross-border acquisitions when factor price differences between countries are small, while greenfield investment plays a more important role for FDI from high-wage into low-wage countries. These results capture important features of the data.

Monopoly Pricing under Demand Uncertainty: Final Sales versus Introductory ffers

We study rationing as a tool of the monopolist’s pricing strategy when demand is uncertain. Three pricing strategies are potentially optimal in our environment: uniform pricing, final sales, and introductory offers. The final sales strategy consists in charging a high price initially, but then lowering the price while committing to a total capacity. Consumers with high valuations to pay may decide to buy at the high price since the endogenous probability of rationing is higher at the lower price. The introductory offers strategy consists in selling a limited quantity at a low price initially, and then raising price. Those consumers with high valuations who were rationed initially at the lower price may find it optimal to buy the good at the higher price. We show that while the introductory offers strategy may dominate uniform pricing, it is never optimal if the monopolist can use the final sales strategy.rationing, priority pricing, sales, demand uncertainty, introductory offer, price dispersion

Monopoly Pricing under Demand Uncertainty: Final Sales versus Introductory Offers

We study rationing as a tool of the monopolist’s selling policy when demand is uncertain. Three selling policies are potentially optimal in our environment: uniform pricing, final sales, and introductory offers. Final sales consist in charging a high price initially, but then lowering the price while committing to a total capacity. Consumers with a high valuation may decide to buy at the high price since the endogenous probability of rationing is higher at the lower price. Introductory offers consist in selling a limited quantity at a low price initially, and then raising price. Those consumers with high valuations who were rationed initially at the lower price may find it optimal to buy the good at the higher price. We show that the optimal selling policy involves either uniform pricing or final sales. Introductory offers may dominate uniform pricing, but can never be optimal if the monopolist can also use final sales.Rationing, priority pricing, sales, demand uncertainty, introductory offer, price dispersion, advance purchase discount