High-cost Firms Research Articles

Monopolistic Competition and Optimum Product Selection

We provide novel insights on the decentralization of optimal outcomes under monopolistic competition with nonseparable utility, variable demand elasticity, and endogenous firm heterogeneity. Relative to the unconstrained optimum, equilibrium firm selection is too weak, average firm size is too small, low-cost firms are too small, and high-cost firms are too large. The unconstrained optimum can be decentralized through differentiated production subsidies to producers financed through lump-sum taxes on entrants and consumers. When differentiated subsidies and transfers from entrants are not viable, the constrained optimum can be decentralized through a common production subsidy financed by a lump-sum tax on consumers.

THE POTENTIAL FOR SHORT-RUN SHIFTING OF A CORPORATE PROFITS TAX

Can the owners of a firm shift a corporate profits tax to consumers? Not in the short run if the tax is stated as a proportion of profits and the firm is a profit maximizer. But what if the firm wishes to pursue a strategy other than profit maximization, say revenue maximization subject to a profit constraint? Under such a condition the firm's reaction to a tax or tax increase might be a price rise that captures part of the foregone profits. We show that firms which operate at a point on their demand curve that differs from profit maximization have an incentive to raise price in response to the tax – and that high cost firms have a greater incentive to raise price than do low cost firms. Our empirical analysis of the US beer industry confirms this finding, and sheds light on the Krzyzaniak–Musgrave analysis of the 1960s which suggested that the corporation income tax produced significant short-run shifting.

Bailout Policy in a Globalized Economy

This paper explores how trade integration influences the decision by national governments to bailout manufacturing firms. We develop a 2-country model of generalized oligopoly with heterogenous firms and trade costs. High-cost firms are eligible for a bailout while low-cost firms are profitable. Our results show that trade liberalization influences both political benefits of a bailout and its relative cost as compared to a laissez-faire policy. If the fall in trade cost is so large that it allows high-cost firms to become exporters, governments might move away from a bailout policy to a laissez-faire policy. In contrast, a marginal decline in trade costs that does not affect the export status of high-cost firms, always makes governments more prone to adopt a bailout decision.

Competing for customers in a social network

Customers' proclivities to buy products often depend heavily on who else is buying the same product. This gives rise to non-cooperative games in which firms sell to customers located in a ``social network''. Nash Equilibrium (NE) in pure strategies exist in general. In the quasi-linear case, NE are unique. If there are no a priori biases between customers and firms, there is a cut-off level above which high cost firms are blockaded at an NE, while the rest compete <em> uniformly</em> throughout the network. Otherwise firms could end up as regional monopolies. <br>&nbsp; &nbsp The connectivity of a customer is related to the money firms spend on him. This becomes particularly transparent when externalities are dominant: NE can be characterized in terms of the invariant measures on the recurrent classes of the Markov chain underlying the social network. <br>&nbsp; &nbsp When cost functions of firms are convex, instead of just linear, NE need no longer be unique as we show via an example. But uniqueness is restored if there is enough competition between firms or if their valuations of clients are anonymous. <br>&nbsp; &nbsp Finally we develop a general model of nonlinear externalities and show that existence of NE remains intact.

Allowing Firms to Choose between Formula Apportionment and Separate Accounting Taxation

This paper analyzes the effect on firm behavior and national tax revenues of a policy of allowing multinational firms to choose whether to be taxed under separate accounting rules (transfer prices) or an apportionment formula. Either method can be preferred by low-cost firms and by high-cost firms, and the preferred method can vary non-monotonically with firm cost characteristics. Separate accounting always generates more profitable output and conditional labor demand distortions while either method can generate a more profitable income-shifting distortion. With asymmetric countries, country preferences are only partially aligned with firm preferences due to the fact that countries and firms value tax base distortions differently. With partial alignment of firm and country preferences, choice can increase tax revenues in both countries.

Yardstick Competition to Elicit Private Information: An Empirical Analysis

The Japanese regulatory authority has introduced a new hybrid regulation that combines a fixed-price contract with ex ante yardstick inspection for local (public utility) gas distribution. The latter compares a firm’s reported costs with those of ‘similar’ firms, and penalizes high-cost firms. We infer the effect of yardstick on information revelation by comparing the actual welfare level with the hypothetical full-information welfare level. Our results suggest that only the very first inspection was effective in reducing firms’ incentive to report higher costs.

Economising, Strategising and the Decision to Outsource

We study the make-or-buy decision of oligopolistic firms in an industry in which final good production requires specialized inputs. Firms’ mode of operation decision depends on both the incentive to economize on costs and on strategic considerations. We explore the strategic incentives to outsource and show that asymmetric equilibria emerge, with firms choosing different modes of operation, even when they are ex-ante identical. With ex-ante asymmetries, higher cost firms are more likely to outsource. We apply our model to a number of different international trading setups.

MARKET COMPETITION, R&amp;D AND FIRM PROFITS IN ASYMMETRIC OLIGOPOLY*

We investigate a Cournot model with strategic R&D investments wherein efficient low-cost firms compete against less efficient high-cost firms. We findthat an increase in the number of high-cost firms can stimulate R&D by the low-cost firms, while it always reduces R&D by the high-cost firms. More importantly, this force can be strong enough to compensate for the loss that arises from more intense market competition: the low-cost firms’ profits may indeed increase with the number of high-cost firms. An implication of this result is far-reaching, as it gives low-cost firms an incentive to help, rather than harm, high-cost competitors. We relate this implication to a practice known as open knowledge disclosure, especially Ford’s strategy of disclosing its know-how publicly and extensively at the beginning of the 20th century.

Market Segmentation: The Rise of Nevada as a Liability-Free Jurisdiction

This Article exposes and analyzes the rise of Nevada as an almost liability-free jurisdiction. Without much public attention, Nevada has embarked on a strategy of market segmentation with a differentiated product — a shockingly lax corporate law. Nevada law generally protects directors and officers from liability for breaches of the duties of loyalty, good faith, and care that are widely believed to be staples of U.S. corporate law. Nevada highlights these broad protections as a reason to incorporate there rather than in Delaware, the dominant state in the interstate market for incorporations. Market segmentation with lax law has allowed Nevada to overcome significant barriers to entry. By tailoring its product to a particular subset of the market, Nevada gained market power in a segment that is not served by Delaware. Nevada’s clear, no-liability law makes Delaware’s competitive advantages less significant and leaves it unable to respond effectively. In offering lax corporate law, Nevada capitalizes on its reputation as a lax regulator. Firms may incorporate in Nevada for a variety of reasons that include extracting private benefits, saving on incorporation taxes, and minimizing litigation costs. The data, however, is consistent with some firms choosing Nevada for the first, less benign reason.Normatively, policymakers should find it worrisome if high agency cost firms, which would benefit the most from legal oversight, disproportionally choose Nevada’s lax law. Another reason for concern is that Nevada may create competitive pressures towards the bottom.

Environmental Regulations, Outward FDI and Heterogeneous Firms: Are Countries Used as Pollution Havens?

We consider whether environmental regulations influence FDI outflows from a country with stringent environmental policy. We consider this issue by incorporating the predictions from the recent heterogeneous firm models of international trade into an empirical model of outward FDI by UK firms. We find that environmental regulations are not a robustly significant determinant of the internationalisation decision. In addition, we do not find robust evidence to suggest that dirtier MNEs are more likely to locate in host countries with lax environmental policy than cleaner MNEs. However, we do uncover systematic differences in the FDI behaviour of high and low environmental cost firms in other respects.

The spatial selection of heterogeneous firms

We show that heterogeneous firms choose different locations in response to market integration. Specifically, decreasing trade costs lead to the gradual agglomeration of efficient firms in the larger country where they have access to a bigger pool of consumers. In contrast, high-cost firms seek protection against competition from efficient firms by locating in the smaller country. However, when the spatial separation of markets ceases to be a sufficient protection against foreign competition, high-cost firms choose to set up in the larger market. Hence, the relationship between economic integration and international productivity gap first increases and then decreases with market integration.

Market Competition, R&amp;D and Firm Profits in Asymmetric Oligopoly

We investigate a Cournot model with strategic R&D investments wherein efficient low-cost firms compete against less efficient high-cost firms. We find that an increase in the number of high-cost firms can stimulate R&D by the low-cost firms, while it always reduces R&D by the high-cost firms. More importantly, this force can be strong enough to compensate for the loss that arises from more intense market competition: the low-cost firms’ profits may indeed increase with the number of high-cost firms. An implication of this result is far-reaching, as it gives low-cost firms an incentive to help, rather than harm, high-cost competitors. We relate this implication to a practice known as open knowledge disclosure, especially Ford’s strategy of disclosing its know-how publicly and extensively at the beginning of the 20th century.

Screening in Courts: On the Joint Use of Negligence and Causation Standards

In legal systems all over the world, injurers are held liable only when the probability of having caused an accident exceeds a critical threshold (causation standard) and when behaving negligently. In a complete information framework, the joint use of the two instruments is puzzling as both whether a potential injurer has taken due care and whether he meets a specific causation standard depend only on his care level. We explain this puzzle with private information about injurers' avoidance costs, and we derive conditions under which the joint use of both instruments can induce self-selection of different cost types. With self-selection, low-cost firms take due care, whereas high-cost firms behave negligently, thereby aiming at escaping liability via the causation standard. Compared to the optimal single-instrument policy, we derive conditions under which such self-selection policies are strictly welfare-enhancing. (JEL K13)

Outsourcing vs FDI in Oligopoly Equilibrium

We consider the make-or-buy decision of oligopolistic firms in an industry in which final good production requires specialized inputs. Factor price considerations dictate that firms acquire the intermediate abroad, by either producing it in a wholly owned subsidiary or outsourcing it to a supplier who must make a relationship-specific investment. Firms’ internationalization mode depends on cost and strategic considerations. Crucially, asymmetric equilibria emerge, with firms choosing different modes of internationalization, even when they are ex ante identical. With ex ante asymmetries, lower cost producers have a stronger incentive to vertically integrate (FDI), while higher cost firms are more likely to outsource. Externalisation contre FDI (Foreign Direct Investment) en équilibre oligopolistique Résumé Cet article concerne la décision de fabriquer ou d'acheter des entreprises oligopolistiques dans une industrie dans laquelle la bonne production finale nécessite des intrants spécialisés. Les considérations de coût du facteur de production obligent les entreprises à acquérir les intermédiaires à l’étranger, soit par leur production dans une filiale en propriété exclusive, soit par externalisation vers un fournisseur qui doit faire un investissement spécifique à la relation. Le mode d'internationalisation des entreprises dépend de considérations de coût et de stratégie. Des équilibres asymétriques émergent de manière critique, les entreprises choisissant différents modes d'internationalisation même lorsqu'elles sont ex ante identiques. Avec des asymétries ex ante, les producteurs à faible coût tendent plus facilement vers l'intégration verticale (FDI), tandis que les entreprises à coût élevé tendent plutôt vers la pratique de l'externalisation. Subcontratación versus inversión extranjera directa (IED [FDI]) en el equilibrio de un oligopolio Résumén Analizamos la decisión de manufactura o compra en compañías oligopolísticas en una industria en donde la producción final de bienes requiere entradas especializadas. Consideraciones sobre el factor precio hacen que las firmas adquieran el intermedio en el extranjero, ya sea elaborándolo en un subsidiario 100% suyo o subcontratándolo a un proveedor quien debe realizar una inversión en base a una relación específica. El modo de internalización de las firmas depende de consideraciones de coste y estratégicas. De forma crucial, equilibrios asimétricos emergen, con firmas eligiendo diferentes modos de internalización, incluso cuando son idénticas ex ante. Con asimetrías ex ante, los productores de bajo coste tienen un incentivo mayor para integrarse verticalmente (IED [FDI]), mientras que es más probable que las firmas de alto coste usen la subcontratación.

On contract duration of royalty licensing contracts

This paper explores how the choice of royalties and contract duration can be a device to mitigate opportunistic behavior in the presence of asymmetric information. It presents a model where an upstream patent holder with no production capabilities licenses a product innovation, by means of royalty-only contracts, to several downstream firms that produce and market the new product. In a two-period signaling model, the profitability of short-term and long-term contracts is compared, given that the licensees’ costs may be inferred by observation of their output levels. For a sufficiently large difference in production costs, the patentee introduces a series of short-term contracts, rather than a long-term contract for the entire expected lifetime of the innovation. In such a sequence of contracts, both high- and low-cost firms pay the same royalty rate (which is not higher than that of long-term contracts) and reveal their costs in the first licensing period. Thereafter, royalties are smaller (than in the first period) for high-cost firms but larger for low-cost producers so as to increase expected total output and licensing income. Overall, royalties are not time-decreasing, in expected terms, as information evolves from incomplete to complete. This strategy is typically welfare-improving.

Tax Competition in a Simple Model with Heterogeneous Firms: How Larger Markets Reduce Profit Taxes

An important puzzle in corporate taxation is that effective tax rates have fallen significantly while tax revenue has simultaneously risen in most countries. Moreover, the gross profitability of firms seems to be lower in high-tax countries, even though standard models of international investment would yield the opposite conclusion. We offer an explanation for these stylized facts by setting up a simple two-country model of tax competition with heterogeneous firms. In this model a unique, asymmetric Nash equilibrium can be shown to exist, provided that countries are sufficiently different with respect to their exogenous market conditions. In equilibrium the larger country levies the higher tax rate and attracts the high-cost firms. A simultaneous expansion of both markets intensifies tax competition and causes both countries to reduce their tax rates, despite higher corporate tax bases.

Dynamic entry and exit with uncertain cost positions

We study the dynamics of entry and exit based on firms' learning about their relative cost positions. Each firm's marginal cost of production is its own private information, thereby facing ex ante uncertainty about its cost position. The (inelastic) market demand can accommodate only a fraction of firms to operate, and thus only firms with relatively lower costs are viable in the long run. Some firms in the market will exit if excessive entry (or overshooting) occurs. We derive the unique symmetric sequential equilibrium. The equilibrium properties are consistent with empirical observations: (i) entry occurs gradually over time with lower cost firms entering earlier than higher cost firms, (ii) exiting firms are among the ones that entered later (indeed in the last period). Moreover, equilibrium overshooting probability is shown to always be positive and decreasing over time.

Learning About Compliance Under Asymmetric Information

Over time, inspection agencies gather information about firms that cause harmful externalities. This information may allow agencies to differentiate their monitoring strategies in the future, since inspections can be influenced by firms' past performance relative to other competitors in the market. If a firm is less successful than its peers in reducing the externality, it faces the risk of being targeted for increased inspections in the next period. This risk of stricter monitoring might induce high cost firms to mimic low cost firms, while the latter might try to avoid being mimicked. We show that under certain circumstances, mimicking, or even the threat of mimicking, might reduce socially harmful activities and thus be welfare improving.

Financial market integration and the value of global diversification: Evidence for US acquirers in cross-border mergers and acquisitions

In contrast to the previously documented cross-border discount, we find that there is positive cross-border effect for US acquirers during late 1990s and early 2000s. This is especially particular the case for those that acquire/merge with targets from segmented financial markets where acquirers experience significantly higher positive abnormal returns than those that acquire targets from integrated financial markets. Furthermore, firms acquiring segmented-market targets are also characterized by significantly higher post-merger operating performance improvement. The results indicate that the observed positive cross-border effect is mainly due to the increase in the number of transactions involving targets from segmented markets, in which the average firm experience significant financial constraints. We contend that value is created by a combination of firms with different financial market integration status, in which funds are provided to high cost firms. The finding that the value creation is even higher within the group of acquirers with a lower cost of capital provides additional support for our conjecture.

Screening in Courts: On the Joint Use of Negligence and Causation Standards

In legal systems all over the world, injurers are held liable only when the probability of having caused an accident exceeds a critical threshold (causation standard) and when behaving negligently. In a complete information framework, the joint use of the two instruments is puzzling as both whether a potential injurer has taken due care and whether he meets a specific causation standard depends only on his care level. We explain this puzzle with private information about injurers' avoidance costs, and we show that the joint use of both instruments can be interpreted as a menu of options to induce self-selection of different cost types. Thereby, low-cost firms have higher incentives to take due care, whereas high-cost firms are negligent and aim at escaping liability via the causation standard. We derive conditions under which the joint use of both instruments outperforms the optimal single-instrument policy.