Fixed Entry Cost Research Articles

Use Rights for Common Pool Resources and Economic Development

This paper explores the long–run development of an economy with a traditional sector based on common-pool resource-use, a modern, resource-independent sector with fixed entry costs, and an imperfect capital market. We show theoretically that introducing resource-use regulations increases incomes in the traditional sector and that this can trigger a development process with labor reallocation to the modern sector. Allowing trade of resource-use rights, or distributing resource-use rights unequally, broadens the scope for development.

Effect of Book Building and Auctions on the Exit Choice between IPO and Acquisition

The choice of exit mechanism between IPOs and acquisitions is an important decision faced by entrepreneurs and private equity investors. Although the decision to go public has been studied extensively, a firm’s choice between IPO and acquisition remains relatively unexplored. In this paper, we extend the existing literature by studying the effect of the type of IPO process on the decision. We introduce the two IPO methods: book building and auctions, and show how the parameters of the IPO methods affect the choice between IPOs and acquisitions. We show that for both the IPO methods, the probability of choosing IPOs decrease when cost to investors for acquiring information increases and fixed entry cost for investors increases. In the case of book building, we show that the probability of choosing IPOs decreases when the number of informed investors in the road-show increases. In the case of auctions, we show that the probability of choosing IPOs decreases when the certainty of the auction being successful decreases and the number of potential bidders increases. We analyse these extensions in two cases: when the firm is controlled by the entrepreneur and when the firm is controlled by the private equity investor. We also discuss important empirical implications which arise out of our theoretical model.

Horizontal Mergers in the Presence of Vertical Relationships

We study welfare effects of horizontal mergers under a successive oligopoly model and find that downstream mergers can increase welfare if they reduce input prices. The lower input price shifts some input production from cost-inefficient upstream firms to cost-efficient ones. Also, the lower input price makes upstream entry less attractive, reduces the number of upstream entrants, and decreases their average costs in the presence of fixed entry costs. We identity necessary and sufficient conditions for a reduction in input prices and welfare-improving horizontal mergers under a general demand function. Qualitative nature of our findings remains unchanged for upstream mergers.

Youtube Decade: Cultural Convergence in Recorded Music

The YouTube platform reduces fixed entry costs for local artists but also lowers the cost of access to international superstars. The net effect is an empirical question. We study the effect of YouTube on the market for music, focusing on converging tastes for international hits. We consider Austria and Germany, which share a common culture and technological development but differ in access to music videos on YouTube. Exploiting a contract dispute that has blocked official music videos in Germany since 2009, we find that YouTube increases the number of US hits on European charts. We further find evidence that YouTube speeds the hitmaking cycle and brings more unique titles to top charts. Although the superstar effect dominates, the magnitude of estimated effects are modest, suggesting that YouTube will not drive out the market for local music.

Bank liquidity, stock market participation, and economic growth

We develop a growth model with banks and markets to reconcile the observed decreasing trend in the relative liquidity of many financial systems around the world with the increasing household participation in direct market trades. At low levels of economic development, the presence of fixed entry costs prevents the agents from accessing the market, and pushes them towards the banks, which provide high relative liquidity. We characterize the threshold after which the agents are rich enough to access the market, where the relative liquidity is lower, and show that the relative liquidity of the whole financial system (banks and markets) drops because of the increasing market participation. We provide some evidence consistent with this theoretical prediction: a one-unit increase in an index of securities market liberalization leads to a drop in the relative liquidity of between 17 and 27 per cent.

Multi‐Market Competition, R&D, and Welfare in Oligopoly

We investigate a multi‐market Cournot model with strategic process research and development (R&D) investments wherein a multi‐market firm meets new competitors that enter one of the markets. We show that entry can enhance the total R&D expenditures of the multi‐market firm. Moreover, the incumbent's profit nonmonotonically changes as the number of entrants increases. Depending on the fixed entry costs and R&D technologies, both insufficient and excess entry can appear. Our results imply that diversification of their products can be a useful strategy for firms.

The Role of Home and Host Country Characteristics in FDI: Firm-Level Evidence from Japan, Korea and Taiwan

There is a large and growing empirical literature that investigates the determinants of outward foreign direct investment (FDI). This literature examines primarily the effect of host country characteristics on FDI even though home country characteristics also influence the decision of firms to invest abroad. In this paper, we examine the role of both host and home country characteristics in FDI. To do so, we constructed a firm-level database of outward FDI from Japan, Korea and Taiwan. Our empirical analysis yields two main findings. First, host countries with better environment for FDI, in terms of larger market size, smaller fixed entry costs and lower wages, attract more foreign investors. Second, firms from home countries with higher wages are more likely to invest abroad. An interesting and significant policy implication of our empirical evidence is that policy-makers seeking to promote FDI inflows should prioritize countries with higher wages.

Tradability and market penetration costs: Explaining foreign market servicing intensities

Industry level data shows striking differences among sectors in ratios of exports to FDI sales. We identify the elements behind the sectoral differences in the mode of foreign market servicing in the context of a general equilibrium model of monopolistic competition. Our calibration exercise shows that traditional margins such as transportation, fixed entry costs, utility weights, and dispersion of firm productivity are not enough to capture the observed sectoral differences, as is commonly assumed. We propose augmenting the model to allow for sectoral differences in intangible costs of operating in a foreign market in order to explain these observations.

Multi-Market Competition, R&D, and Welfare in Oligopoly

We investigate a multi-market Cournot model with strategic process R&D investments wherein a multi-market monopolist meets entrants that enter one of the markets. We find that entry can enhance the total R&D expenditure of the incumbent firm. That is, entry can stimulate R&D effort. Moreover, the incumbent’s profit nonmonotonically changes as the number of entrants increases. Depending on the fixed entry costs and R&D technologies, both insufficient and excess entry can appear.

Component-Based Technology Transfer in the Presence of Potential Imitators

Technology transfer to low-cost locations offers global firms an opportunity to reduce their variable costs involved in serving emerging markets. However, such moves may also make imitation by local competitors easier. As a consequence, technology transfer may create competition in the local market. We introduce component-based technology transfer for the global firm as a means to deter or accommodate the imitators' entry, recognizing that components may differ in technological complexity. By choosing a subset of components to transfer, the global firm's decision has an impact not only on the imitators' fixed entry costs, but also on postentry competition based on variable costs. Our research identifies two different types of deterrence strategies—the barrier-erecting strategy and the market-grabbing strategy. In the former deterrence strategy, the global firm retains enough component technology in the home country to make the potential imitator's fixed entry costs so high that it is not worthwhile entering. In the latter deterrence strategy, the global firm transfers enough component technology to the emerging market, reducing the global firm's variable cost to make the potential imitator's revenues so low that it is not worthwhile entering. Which deterrence strategy the global firm should employ depends on the degree to which geographical proximity reduces imitation costs and the degree of differentiation between the local firm's and the global firm's products. Some other interesting and counterintuitive results arise. For example, it may benefit a global firm to transfer less technology for products with a higher emerging market potential.

CONTEST DESIGN AND OPTIMAL ENDOGENOUS ENTRY

This paper derives the effort‐maximizing contest rule and the optimal endogenous entry in a context where potential participants bear fixed entry costs. The organizer is allowed to design the contest under a fixed budget with two strategic instruments: the value of the prize purse and a monetary transfer (entry subsidy/fee) to each participating contestant. The results show that the optimally designed contest attracts exactly two participating contestants in its unique subgame perfect equilibrium and extracts all the surplus from participating contestants. The direction (subsidy or fee) and amount of the monetary transfer depend on the magnitude of the entry cost. (JEL C7, D7)

On the Possibility of Profitable Self‐Selection Contracts in Competitive Insurance Markets

AbstractSeveral studies extend the Rothschild–Stiglitz model of competitive insurance contracting with adverse selection by incorporating additional dimensions of private information and conclude that some insurers may earn positive profit in a separating, self‐selection equilibrium, provided each insurer is restricted to making a single contract offer. The main result of this article is that these profitable configurations are not sustainable when individual insurers can offer multiple contracts. It is also shown that the ability to offer multiple contracts overturns equilibria that have applicants from different risk classes pooled as well as those where profits are dissipated by a fixed entry cost.

Firm Dynamics with Infrequent Adjustment and Learning

Recent empirical findings have emphasized post entry growth of survivors, as opposed to exit of inefficient and small firms, as the main source of growth over time in the average size of a cohort of entering firms. In this paper, as an explanation for the significant growth of survivors, we suggest the interaction of adjustment costs with learning by entering firms about their true efficiency. Initial uncertainty about true profitability makes entering firms prudent since they want to avoid incurring superfluous costs on jobs that prove to be excessive ex post. We propose a decomposition of the change in a cohort’s average size into a survivor component and a selection component. For the 1988 cohort of entrants in the Portuguese economy, we conclude that survivors have the highest contribution to changes in the cohort's average size. However, initial selection is stronger and the survivor’s component is much smaller in Services than in Manufacturing. A calibration of the model suggests that proportional costs and the fixed entry cost are key parameters in matching the evidence on firm dynamics. Firms in Manufacturing learn relatively less initially about their efficiency, and are subject to much larger adjustment costs than firms in Services

A model of market power in electricity industries subject to peak load pricing

This paper studies the exercise of market power in price-regulated electricity industries under peak-load pricing and merit order dispatching, but where investment decisions are taken by independent generating companies. Within this context, we show that producers can exercise market power by under-investing in base-load capacity, compared to the welfare-maximizing configuration. We also show that when there is free entry with an exogenous fixed entry cost that is later sunk, more intense competition results in higher welfare but fewer firms.

Environmental groups in monopolistic markets

We examine a market in which a monopolistic firm supplies a good. The production of the good causes damage to the environment. Consumers are heterogeneous with respect to their disutility of the environmental damage. An environmental group can enter the market and set up a campaign in order to influence consumers’ preferences. We characterize the equilibrium of the resulting entry-deterrence game and investigate its properties. It turns out that the aggregated environmental damage is lowest if the firm is able to deter entry of the environmental group and, moreover, the fixed entry cost of the environmental group is small enough.

Investment timing decisions in a stochastic duopoly model

We investigate the role of strategic considerations on the optimal timing of investment when firms compete for a new market (e.g., the provision of an innovative product) under demand uncertainty. Within a continuous time model of stochastic oligopoly, we show that strategic considerations are likely to be of limited impact when the new product is radically innovative whilst the fear of a rival's entry may deeply affect firms' decisions whenever innovation is to some extent limited. The welfare analysis shows surprisingly that the desirability of the different market structures considered does not depend on the fixed entry cost. (c) 2005 Elsevier Ltd. All rights reserved.

Technological Capability and FDI in Asia: Firm‐level Relationships among Japanese Manufacturers*

The present paper reexamines the relationship between technological capabilities and FDI decisions at the firm level. The data cover 118 300 Japanese firms in all manufacturing industries. The R&D of Japanese firms has a noticeably weaker relationship with FDI in Asia than with FDI in industrial countries. This finding is confirmed to be robust even when alternative estimation techniques are used and when R&D expenditure data are replaced by patent data. The estimation results also reveal non‐negligible fixed entry costs for FDI, a finding consistent with the observation that only approximately 2 percent of the firms invest abroad.

Free Riding in Noncooperative Entry Deterrence with Differentiated Products

1. IntroductionThis paper reexamines the phenomenon of free riding in entry deterrence when established firms in an oligopoly are unable to coordinate their entry preventing activities. Previous authors (e.g., Bernheim 1984; Gilbert and Vives 1986; Waldman 1987, 1991; Appelbaum and Weber 1992) have highlighted the public good aspect of noncooperative entry prevention--if costly entry deterring actions are successfully undertaken by a proper subset of the incumbents, then incumbents outside of that subset cannot be excluded from the benefits of deterred entry. It is in this sense that entry deterrence acquires the nature of a public good. This observation has prompted previous researchers to raise the "free rider" question (with its associated welfare implications): Can there occur underinvestment in entry deterrence due to the incentive for each firm to free ride on the others' (costly) entry preventing activities?The free rider problem in entry deterrence is first mentioned in the sequential entry model of Bernheim (1984). However, though Bernheim discusses the possibility of free riding in his model, the free rider problem is not the main focus of his paper. In fact, as pointed out by Waldman (1987, p. 309, footnote 2), the author's discussion of the role of the free rider problem is "... somewhat vague as regards whether Bernheim feels the free rider problem would ever be important in a noncooperative entry deterrence setting."1Gilbert and Vives (1986) is the first paper in which the underinvestment issue is explicitly addressed. The authors define underinvestment in entry deterrence to be associated with one or more of the following:"(a) Incumbents' total profits are higher preventing than allowing entry, but the (unique) industry equilibrium allows entry.(b) Either entry prevention or entry may be an industry equilibrium, but incumbents' profits are higher when entry is prevented.(c) An established monopoly (or colluding incumbents) prevents entry in more situations than an established, noncooperating oligopoly." (p. 77) Label (a), (b), and (c) as underinvestment of type 1, 2, and 3, respectively. Gilbert and Vives (G&V) go on to show that in none of these respects is there underinvestment in their quantity setting homogeneous product model. On the contrary, they demonstrate a strong possibility of overinvestment.G&V consider a situation where symmetric noncooperative incumbents with constant marginal costs of production make credible commitments to outputs in the preentry stage.2 The entrant incurs a fixed entry cost if it enters the industry and makes its entry and output decision after observing the incumbents' output choices. Consequently, there exists a "limit output," which if jointly produced by the oligopoly, deters entry.3 G&V find that entry is prevented when limit outputs are small, while entry is allowed for larger limit outputs. For limit outputs in an intermediate range, both allowing entry and preventing entry are equilibria. They prove that in this intermediate range where both entry accommodating and entry preventing equilibria coexist, the unique entry equilibrium Pareto dominates every deterrence equilibrium. In other words, compared with any deterrence equilibrium (there is typically a continuum of such equilibria) the accommodation equilibrium yields strictly higher profits to every incumbent. Hence, if the industry settles on an entry preventing equilibrium, the implication is that overinvestment exists because, by jointly reducing incumbents' outputs and allowing entry, every incumbent can be made better off.This paper introduces product differentiation into the G&V model and shows that sufficiently large amounts of product differentiation can generate underinvestment in entry prevention. The intuition is straightforward. Consider an incumbent's profit in any entry deterring equilibrium where exactly the limit output is produced by the oligopoly. …

Foreign outsourcing and firm-level characteristics: Evidence from Japanese manufacturers

Based on micro data of 118,300 firms without firm-size thresholds covering all manufacturing industries in Japan, this paper investigates the foreign outsourcing, distinguished explicitly from domestic outsourcing, at the firm level. Less than three percent of the firms are outsourcing their production across national borders. The fixed entry cost for foreign outsourcing is significant and related with the firm's human skills and foreign business experience. The firms tend to outsource more of their activities overseas when their productivity is higher or when their products are more labor-intensive. J. Japanese Int. Economies 19 (2) (2005) 255–271.

Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence

We show that a life-cycle model with realistically calibrated uninsurable labor income risk and moderate risk aversion can simultaneously match stock market participation rates and asset allocation decisions conditional on participation. The key ingredients of the model are Epstein-Zin preferences, two risky assets (stocks and long-term bonds), and a fixed entry cost associated with the investment in risky assets. In this context, moderate preference heterogeneity in risk aversion and in the elasticity of intertemporal substitution is sufficient to deliver our results. Moreover, the model rationalizes the asset allocation puzzle of Canner, Mankiw and Weil (1997).