The Great Industry Gamble: Market Structure Dynamics with Moral Hazard

Abstract

I investigate the dynamic effect of moral hazard on market structure in a general framework. In this model the evolution of market structure determines the severity of moral hazard and, in turn, moral hazard fuels market structure dynamics through a survival contest. In the absence of scale economies I show that the presence of moral hazard results in a convergence towards market concentration regardless of the intensity of competition. On the other hand, the dynamics leading to market concentration reduces moral hazard even when prices do not increase with concentration (e.g. Bertrand competition). Therefore, the main policy implication is that market concentration can be effective against moral hazard and as such, welfare increasing. The model is suitable to explain the puzzling market transformation of industries such as banking, health care and audit.