A Theory on Predatory Advertising After a Demand-Reducing Shock

Abstract

We model the advertising competition between an incumbent and a new entrant in multiple independent markets after the new entrant suffers a demand-reducing shock. The incumbent is privately informed about the effect of the shock, and has incentive to signal the entrant its private information in order to induce the entrant to exit. Under the assumption that the entrant has established different loyalty levels across different markets, we show that the predatory incentive of the incumbent upward distorts the incumbent's advertising, and such distortion occurs only among the markets where loyalty to the entrant falls in the medium range. In the rest of the markets, the incumbent advertises at its normal competitive level. Our results offer empirically testable predictions on predation, and a rationale to the empirical findings in Chen and Tan [2011].