bluuebunny/crossref_metadata_2025 huggingface dataset:
Product Switching Cost and Strategic Flexibility
Authors: Chang Myong‐Hun
Published: January 2004

This paper examines the equilibrium degree of flexibility adopted by firms competing in oligopolistic product markets in which the value of flexibility arises from the initial presence of uncertainty over consumer preferences and its eventual resolution. The equilibrium choice of flexible mode depends on the following factors: (1) the cost of switching product design in response to revealed consumer preferences, (2) the difference in the acquisition costs of the flexible and dedicated modes, and (3) the precision of the ex ante information held by the firms regarding consumer preferences. The relationship between these factors and the equilibrium choice of modes is fully characterized.
Corporate Control Through Board Dismissals and Takeovers
Authors: Hirshleifer David , Thakor Anjan V.
Published: January 2004

This paper examines some policy issues related to the interaction between internal and external corporate control mechanisms—board dismissals and takeovers—by focusing on the information aggregation and other effects related to this interaction. We model the functioning of corporate control mechanisms as an example of a multilayered principal‐agent relationship in which shareholders delegate the task of monitoring management quality to the board and rely on the external takeover market to provide additional disciplining of the manager as well as of the board. This gives rise to two effects: (1) a substitution effect, whereby the takeover market partially substitutes for board dismissal of the manager, leading to greater lenience toward the manager by a board acting in the shareholders' best interest, and (2) a kick‐in‐the‐pants effect, whereby the board is stricter with the manager because it may be dismissed by a successful acquirer who views it as lax. The interaction of these two effects leads to various implications about the behavior of boards and potential acquirers. In particular, a well‐functioning internal control mechanism (the board) does not obviate the need for external control (takeovers). Moreover, somewhat counterintuitively, there may be a greater incidence of takeovers when the internal control mechanism is working well than when it is not.
Rational Nonprofit Entrepreneurship
Authors: Bilodeau Marc , Slivinski Al
Published: January 2004

This paper derives the decision to found a nonprofit firm as the equilibrium outcome of a multistage game among individuals who would like a public good to be provided. The model predicts that if individuals will voluntarily contribute towards provision of the public good, then it is in the self‐interest of the entrepreneur to impose a nondistribution constraint on herself by founding a nonprofit firm.
Agency‐Theory and Internal‐Labor‐Market Explanations of Bonus Payments: Empirical Evidence from Spanish Firms
Authors: Ortín‐Ángel Pedro , Salas‐fumás Vicente
Published: January 2004

This paper combines agency theory and internal‐labor‐market theories to explain the determinants of bonus payments among a large sample of top and middle managers from Spanish firms. A distinction is made between the decision whether to pay bonus or not and the size of the bonus. The empirical evidence confirms that the two decisions are determined by different factors. The results of the analysis show a trade‐off between short‐term and long‐term incentives (bonuses and promotion opportunities) as well as differences in the pattern of compensation policies across economic sectors and functional areas inside the firm.
Entry Deterrence, Product Quality: Price and Advertising as Signals
Authors: Linnemer Laurent
Published: January 2004

I analyze the marketing strategy of an incumbent monopolist facing a threat of entry. Product quality is unknown to consumers, and the monopolist's cost is unknown to the potential entrant. The incumbent uses both price and advertising to signal cost and quality. The monopolist faces a dilemma because signaling a high quality attracts customers but requires a high price, whereas signaling low cost prevents entry but requires a low price. I characterize the unique (stable) separating equilibrium and show that dissipative advertising may be used, while it is never used if either quality or cost is known. Some equilibria may involve pooling on cost. A welfare analysis indicates that potential entry may improve welfare and that the effect of unknown quality is not always negative when it interferes with entry deterrence.
Minimum Advertised Price
Authors: Kali Raja
Published: January 2004

This paper examines minimum advertised price (MAP), a vertical restraint that is observed in manufacturer‐retailer interactions. Under MAP, the manufacturer announces that it will reimburse retailers for a fraction of their advertising expenditures if retailers do not advertise the product at below a specified price. MAP can be considered a combination of resale price maintenance (RPM) and a cooperative advertising subsidy. Current antitrust law treats RPM as illegal per se, whereas MAP is judged according to a rule of reason. A framework is presented within with neither a minimum retail price nor a cooperative advertising subsidy is individually sufficient to enable maximization of profits in the complete manufacturer‐retailer structure, but the two instruments together are. MAP is therefore a sufficient instrument for the maximization of joint profits. We argue that MAP can also be designed as a second‐best instrument that replicates RPM.
Adverse Selection with Competitive Inspection
Authors: Biglaiser Gary , Friedman James W.
Published: January 2004

We develop a model with heterogeneous buyers and sellers in which the sellers have private information about their goods' qualities. We show that efficient trading cannot occur without middlemen. Middlemen can provide two services: one is inspection, and the other is the sorting of buyers and sellers through the rationing of sellers and the provision of two different price schedules. The latter service permits the possibility of achieving the first best. When the first best is not attainable, there is a second best characterized by two intervals, one consisting of low‐quality noninspected goods, and the other of high‐quality inspected goods. We determine whether first and second best outcomes can be implemented in a market equilibrium with both zero and infinite buyer‐seller search costs. First and second best outcomes are attainable under a larger set of parameter values when search costs are infinite; also, typically too much inspection occurs in a market equilibrium. Welfare may be either raised or lowered by the introduction of middlemen.
A Reexamination of Yardstick Competition
Authors: Sobel Joel
Published: January 2004

This paper shows that yardstick competition does not assist a regulator when lump‐sum transfers are not costly and the regulator does not care about the distribution of income. Yardstick competition may discourage investment that would make efficient operation possible. The paper characterizes optimal regulatory schemes in a simple model and demonstrates that it may be optimal to limit the amount of information available to the regulator.
Empirical Evaluation of Regulatory Regimes in Local Telecommunications Markets
Authors: Gasmi F. , Laffont J. J. , Sharkey W. W.
Published: January 2004

This paper relies on an engineering optimization model of the local telecommunication exchange network to calibrate the functions entering various regulatory mechanisms, from both traditional and modern (incentive) regulation, and evaluate their relative performance. The engineering process model is used to generate data, which are econometrically synthesized in a translog economic cost function. Using this estimated cost function and some empirical and institutional information on market and regulatory conditions, we then calibrate demand, social‐surplus, and disutility‐of‐(cost‐reducing)‐effort functions. These functions, together with probability distributions reflecting the regulator's beliefs about technology characteristics, allow us to quantitatively assess the social value of regulatory transfers and of good cost auditing procedures, the redistributive consequences of the various forms of regulation, and the sensitivity of their relative performance to the cost of public funds.
Price Dynamics and Consumer Learning
Authors: Caminal Ramon , Vives Xavier
Published: January 2004

This paper studies the price dynamics induced by strategic firm behavior in the presence of consumer learning about the uncertain quality differential of the products offered by a duopoly. It is found that consumers learn slowly and that prices converge also slowly to full‐information levels. A consequence is that the incentives affirms to manipulate consumers' beliefs are persistent. Although pricing tends to be aggressive at the early stages, and average prices eventually increase over time, price wars may occur at intermediate stages of the product life cycle.
Licensing vs. Litigation: The Effect of the Legal System on Incentives to Innovate
Authors: Aoki Reiko , Hu Jin‐Li
Published: January 2004

With uncertain scope of patent protection and imperfect enforcement, the effective strength of patent protection is determined by the legal system. We analyze how the legal system affects the incentives of firms to innovate, taking into account possibilities of strategic licensing and litigation to deter imitation. The legal system that guarantees the patentee's monopoly power maximizes the R&D intensities. However, the legal system that induces licensing provides incentives to exert R&D effort while preserving ex post efficiency. We also compare R&D, patent licensing, and litigation behavior under American and English rules of legal cost allocation.
Termination and Coordination in Partnerships
Authors: Minehart Deborah , Neeman Zvika
Published: January 2004

It is common practice for firms to pool their expertise by forming partnerships such as joint ventures and strategic alliances. A central organization problem in such partnerships is that managers may behave noncooperatively in order to advance the interests of their parent firms. We ask whether contracts can be designed so that managers will maximize total profits. We characterize first best contracts for a variety of environments and show that efficiency imposes some restrictions on the ownership shares. In addition, we evaluate the performance of two termination contracts that are widely used in practice: the shotgun rule and price competition. We find that although these contracts do not achieve full efficiency, they both perform well. We provide insight into when each rule is more efficient.
Effects of One‐Way Spillovers on Market Shares, Industry Price, Welfare, and R & D Cooperation
Authors: Amir Rabah , Wooders John
Published: January 2004

With one‐way spillovers, the standard symmetric two‐period R&D model leads to an asymmetric equilibrium only, with endogeneous innovator and imitator roles. We show how R&D decisions and measures of firm heterogeneity—market shares, R&D shares, and profits—depend on spillovers and on R&D costs. While a joint lab always improves on consumer welfare, it yields higher profits, cost reductions, and social welfare only under extra assumptions, beyond those required with multidirectional spillovers. Finally, the novel issue of optimal R&D cartels is addressed. We show an optimal R&D cartel may seek to minimize R&D spillovers between its members.
Foreign Direct Investment Strategies and Firms' Capabilities
Authors: Siotis Georges
Published: January 2004

This paper presents a simple model to analyze the effect of geographically localized spillovers on the internationalization decision of firms. It is shown that, once spatially bounded externalities are taken into account, the standard predictions on the nature and direction of foreign direct investment (FDI) flows may be reversed. We highlight three effects. First, an FDI‐en‐hancing effect: the presence of spillovers increases the profitability of the FDI strategy when the competitive gap between firms is narrow. Second, a dissipation effect: firms may refrain from investing abroad for fear of diffusion of their firm‐specific assets. Third, a sourcing effect: the presence of spillovers may induce a firm to invest abroad, even in the absence of exporting costs.
Policy Shocks, Market Intermediaries, and Corporate Strategy: The Evolution of Business Groups in Chile and India
Authors: Khanna Tarun , Palepu Krishna
Published: January 2004

Numerous countries have undergone rapid transitions in their economic environments. Yet, little is known about firms' responses to such transitions. We use field‐collected data to study the evolution of eighteen large and diversified business groups in Chile (1987–1997) and India (1990–1997). The chosen periods correspond to significant deregulation in the primary markets in both countries. Conventional wisdom suggests that the intermediation roles played by business groups ought to decrease during these periods. However, we find an increase in group scope, an increase in the strength of the social and economic ties that bind together group firms, an increase in self‐reported intermediation attempts by the groups, and some evidence that these actions are associated with improvements in accounting and stock‐market performance of the group affiliates. We suggest that the slow development of market intermediaries, in a manner suggested by institutional economics, and the attendant lack of reduction in transaction costs in primary markets, can explain these findings.
Using Subjective Risk Adjusting to Prevent Patient Dumping in the Health Care Industry
Authors: Sappington David E. M. , Lewis Tracy R.
Published: January 2004

We examine how to procure health care services at minimum cost while preventing suppliers from refusing to care for high‐cost patients. A single risk‐adjusted prospective payment is optimal only when it is particularly costly for the supplier to discover likely treatment costs. Cost sharing is optimal when these screening costs are somewhat smaller. When screening costs are sufficiently small, screening is optimally accommodated and subjective risk adjusting is implemented. Under subjective risk adjusting, the supplier classifies patients according to his personal assessment of likely treatment costs, and payments are structured accordingly. Optimal procurement policies are contrasted with prevailing industry policies.
Measuring Hospital Cost‐Sharing Incentives Under Refined Prospective Payment
Authors: Gilman Boyd H.
Published: January 2004

This paper evaluates the usefulness of a model (McClellan, 1997) that was recently proposed for measuring reimbursement incentives under ongoing refinements to the hospital prospective payment system. The model is applied to a single major disease category (HIV infection) for which the hospital reimbursement system has undergone dramatic refinements in recent years. The paper highlights a problem in the original specification, namely, the use of endogenous costs as an explanatory variable. The paper illustrates how hospital response to both marginal price incentives (e.g., a change in the supply of payment‐related services) and average price incentives (e.g., a change in the supply of non‐payment‐related services) can cause either over‐or underestimation of payer cost sharing. In the present case study, overestimation of the marginal reimbursement incentives was evidenced. Obtaining cost‐sharing estimates that can be used to evaluate alternative payment classification systems requires controlling for endogenous changes in hospital behavior.
Process‐ Versus Function‐Based Hierarchies
Authors: Rotemberg Julio J.
Published: January 2004

I consider a firm's choice between having people who carry out complementary tasks report to the same manager and having them report to separate, function‐based managers. Even supposing that the former enhances coordination, the latter may be preferred because it improves the firm's control over employees. I show that, because switching from a function‐based hierarchy to a process‐based hierarchy reduces the firm's direct control, it raises the attractiveness of making the employee pay more sensitive to performance. Also, this switch tends to raise the profitability of fostering altruism between employees. I extend the analysis so that it deals with the relative benefits of IT‐ and M‐form organizations. I show that the M form becomes more profitable as the firm gets large.
Hassle Costs: The Achilles' Heel of Price‐Matching Guarantees*
Authors: Hviid Morten , Shaffer Greg
Published: January 2004

We show that price‐matching guarantees can facilitate monopoly pricing only if firms automatically match prices. If consumers must instead request refunds (thereby incurring hassle costs), we find that any increase in equilibrium prices due to firms' price‐matching policies will be small; often, no price increase can be supported. In symmetric markets price‐matching guarantees cannot support any rise in prices, even if hassle costs are arbitrarily small In asymmetric markets, higher prices can be supported, but the prices fall well short of maximizing joint profits. Our model can explain why some firms adopt price‐matching guarantees while others do not.
Coupon Advertising Under Imperfect Price Information*
Authors: Moraga‐González José Luis , Petrakis Emmanuel
Published: January 2004

This paper studies sales promotions through coupons in an oligopoly under imperfect price information. Sellers can distribute either ordinary coupons, or coupon (price) advertising, or both types of coupons, at distant locations to attract consumers from their rivals' markets. A unique symmetric pure‐strategy equilibrium exists where rebates and couponing intensity are always positive. In the ordinary‐coupon equilibrium, prices, promotional efforts, and sellers' profits are higher than in the coupon‐advertising equilibrium. However, if sellers are allowed to distribute both types of coupons, only coupon advertising is sent out in equilibrium.
Quality Competition, Insurance, and Consumer Choice in Health Care Markets
Authors: Lyon Thomas P.
Published: January 2004

In this model, insurance offering a choice of hospitals is valued because consumers are uncertain which hospital they will prefer ex post. A competitive insurance market facilitates tacit price collusion between hospitals; high margins induce hospitals to compete for customers through overinvestment in quality. Incentives may exist to lock in market share via managed‐care plans with less choice and lower prices. As technology becomes more expensive, the market increasingly offers too little choice. A pure managed care market may emerge, with underinvestment in quality. Relative to a pure insurance regime, however, all consumers are better off under managed care.
Product Differentiation, Strategic Divisionalization, and Persistence of Monopoly
Authors: Yuan Lasheng
Published: January 2004

This paper analyzes the strategic incentive of oligopolists to create autonomous rival divisions when products are differentiated. We consider a two‐stage game where firms choose the number of autonomous divisions in the first stage and all the divisions engage in Cournot competition in the second. It is shown that product differentiation ensures the existence of an interior subgame perfect Nash equilibrium (SPNE), and the equilibrium number of divisions increases with the degree of substitution among products and the number of firms. Further, if divisions are allowed to divide further, they always will, which leads to total rent dissipation. Thus, parent firms have incentives to unilaterally restrict their divisions from further dividing. In the free‐entry equilibrium, it is found that the possibility of setting up autonomous divisions is a natural barrier to entry. Incumbents may persistently earn abnormally high profits. In the cases where product differentiation is difficult, the only pure‐strategy free‐entry SPNE is the monopoly outcome even if the entry cost is relatively low.
Intermediation Can Replace Certification
Authors: Garella Paolo G. , Peitz Martin
Published: January 2004

We consider a market in which consumers do not have perfect information about product quality. Producers can perfectly reveal that a good is of high quality through certification, which entails socially wasteful costs. Firms can choose whether to sell through an intermediary or to sell independently (vertical integration). We show that multibrand retailing, which leads to a redistribution of profits but not to social costs, can fully or partially replace certification by signaling product quality. Renting the image of a competing high‐quality brand is shown to be an outcome that can be sustained through intermediation.
Systems Competition, Vertical Merger, and Foreclosure
Authors: Church Jeffrey , Gandal Neil
Published: January 2004

We address the possibility of foreclosure in markets where the final good consists of a system composed of a hardware good and complementary software and the value of the system depends on the availability of software. Foreclosure occurs when a hardware firm merges with a software firm and the integrated firm makes its software incompatible with a rival technology or system. We find that foreclosure can be an equilibrium outcome where both the merger and compatibility decisions are part of a multistage game which permits the foreclosed hardware firm to play a number of counter‐strategies. Further, foreclosure can be an effective strategy to monopolize the hardware market.
Contract Mixing in Franchising as a Mechanism for Public‐Good Provision
Authors: Bai Chong‐En , Tao Zhigang
Published: January 2004

This paper is concerned with the coexistence of company‐owned units and franchised units in business format franchising and their different contractual arrangements. Drawing insights from case studies that indicate both the development and the maintenance of company‐wide brand names and unit‐specific sales activities are crucial to a franchise company, we construct a multitask model to account for such contract mixing in franchising. Intuitively, low‐powered contracts are offered to some managers to induce effort for brand‐name development and maintenance, while high‐powered contracts are offered to the remaining managers to elicit sales activity and capture the beneficial effect of the company brand name. Franchising can thus be viewed as an organizational agreement for production involving brand‐name products and services.
The Effect of Organizational form on Information Flow and Decision Quality: Informational Cascades in Group Decision Making
Authors: Slezak Steve L. , Khanna Naveen
Published: January 2004

This paper identifies a disadvantage to decision making in a team. We show that in some cases available information is lost due to sequential communication that results in informational cascades. Although incentive contracts exist that prevent cascades, in some cases these contracts do not maximize shareholders' expected residual value and cascades are tolerated in equilibrium. Cascades never occur in hierarchies that exogenously prevent communication. However, when the firm is organized as a hierarchy (and the agents are given the optimal hierarchical contract), in some cases agents will collude and sequentially communicate, admitting the possibility of cascades. In these cases, the principals must monitor and enforce the hierarchical process. When monitoring costs exceed the cost of cascades, the team is the optimal organizational form.
Takeover Waves
Authors: Fauli‐Oller Ramon
Published: January 2004

Horizontal takeovers often occur in waves. A sequence of takeovers is obtained in a Cournot setting with cost asymmetries. They are motivated by two different reasons: (1) a low realization of demand increases the profitability of takeovers; (2) takeovers raise the profitability of future takeovers. A possible explanation of merger races is also obtained by showing that firms buying in the first place pay a lower price for their targets.
Vertical Foreclosure, Technological Choice, and Entry on the Intermediate Market
Authors: Avenel Eric , Barlet Corinne
Published: January 2004

This paper analyzes the profitability of vertical integration for an upstream monopoly facing a potential competitor. We show that it depends on the technology used by the firm when it integrates. We distinguish two types of technologies: standard technologies, used by nonintegrated firms, and nonstandard technologies, reserved for integrated firms and implying the complete foreclosure of nonintegrated firms. Vertical integration with the adoption of a nonstandard technology dominates vertical integration with the adoption of a standard technology and is profitable, as long as the degree of competition in the downstream industry is sufficiently low.
External Liberalization and Foreign Presence: Cross‐Industry Evidence from Poland and Hungary
Authors: Kennedy Robert E.
Published: January 2004

External liberalization—the relaxation of restrictions on cross‐border trade and inbound direct investment—has played an important role in the programs of economic transition in central Europe. While liberalization is widely heralded, there has been little empirical analysis of the links between liberalization and industry structure. This analysis examines changes in foreign presence following external liberalization in Poland and Hungary. I show that the presence of proprietary and intangible assets explains much of the cross‐industry variation in patterns of foreign presence and, for a given level of foreign presence, whether this will occur via trade or inbound direct investment.
Graft, Bribes, and the Practice of Corruption
Authors: Carrillo Juan D.
Published: January 2004

We construct a dynamic model of corruption in organizations where officials privately know their propensity for corruption and clients optimally choose the bribe offered. We show that there is a continuum set of stationary bribe equilibria due exclusively to the dynamic nature of the model and the endogenous determination of bribes. This can explain why similar countries have stable but different “implicit prices” for the same illegal services. We also show that, by not considering the reaction of clients, traditional analysis have systematically overestimated the beneficial effect of increasing wages as an anticorruption measure.
Multimarket Contact and Price Coordination in the Cellular Telephone Industry
Authors: Busse Meghan R.
Published: January 2004

Empirical studies have confirmed the prediction of theoretical models that contact in multiple markets may enhance firms' abilities to tacitly collude and consequently achieve higher prices and profits. It has remained largely unexplored, however, how firms coordinate their actions. This paper identifies a method of pricing in the cellular telephone industry that seems to enable firms to coordinate their actions across markets. This pricing pattern is found to raise prices by approximately 7–10%, and cannot be attributed to a variety of noncooperative explanations.
Divisionalization and Delegation in Oligopoly
Authors: González‐Maestre Miguel
Published: January 2004

We consider a model where oligopolistic firms create independent divisions or franchises, which subsequently delegate output decisions to managers. We show that the number of firms required to make divisionalization privately profitable is greater in our model than in previous pure divisionalization models. However, in contrast with pure delegation models, we show that the subgame perfect Nash equilibrium approaches perfect competition as divisionalization costs tends to zero, even with a small fixed number of firms.
Focused Firms and the Incentive to Innovate
Authors: Corts Kenneth S.
Published: January 2004

This paper explores the possibility that a firm may make a credible strategic commitment to high levels of innovation by limiting its horizontal or vertical scope. Specifically, I develop a model in which a firm decides whether to undertake an innovation that affects a system of products, which can also be interpreted as multiple stages of the production process. The products are technologically related, and innovation in the core product is assumed to impose costs on the producers of ancillary products, due to cannibalization of the old technology and redesign or retooling costs, for example. I demonstrate that a firm may optimally and credibly commit to innovate by choosing to be a focused firm and licensing the production of the ancillary product, even when licensees are inefficient. In stark contrast to the irrelevance results of the strategic delegation literature, this commitment may be credible even when licensing contracts are renegotiable, but only if licensees are sufficiently inefficient.
Regulatory Reform and Bureaucratic Responsiveness to Firms: the Impact of User Fees in the FDA
Authors: Olson Mary K.
Published: January 2004

This paper examines the impact of user fees on the speed of new‐drug review and on the responsiveness of FDA reviewers to pharmaceutical firms. User fees are expected to alter FDA behavior and responsiveness to pharmaceutical firms because they give regulators a financial incentive to process more new‐drug applications and because they convey information to regulators that may reduce type I error. The analysis examines the variation in FDA review times for new drugs approved between 1990 and 1995 as a function of differences that exist among firms and drugs. Specifically, it compares estimates of regulator responsiveness to several firm and drug characteristics before and after the introduction of user fees. The results show that user fees produced a significant change in FDA behavior. Regulators have become less responsive to the differences among firms since the introduction of user fees, which suggests that the reform has led to more equity in the new‐drug review process. In addition, the FDA has expedited the review of new drugs, especially the most therapeutically novel drugs, which suggests that politicians have been fairly successful in designing a reform to realign regulatory incentives in the FDA.
Reputation, Honesty, and Efficiency with Insider Information: an Experiment
Authors: Charness Gary , Garoupa Nuno
Published: January 2004

We conduct an experimental study of sales of insider information about an asset's future value, where the insiders cannot purchase the underlying asset. We examine whether such information is purchased, the quality of the information provided, and the subsequent accuracy of purchase decisions in the underlying asset market. Our design explores whether reputation, in a repeated game of finite (but uncertain) duration, is an effective constraint on deliberate strategic misinformation. The insiders have an immediate incentive to state that the asset value is high when its true value is low. We suggest an application to insider trading in financial information markets. With fixed matching, cooperative outcomes featuring truthful revelation are frequently achieved and sustained, even though this suggests subjects have sophisticated beliefs about the beliefs and behavior of others. As a comparison, we also conduct a control treatment with random rematching. Here, information purchase is less frequent, the rate of truthful revelation decreases, and efficiency is diminished. Our results suggest that most people anticipate that others realize the potential value of a good reputation.
Renegotiation and Collusion in Organizations
Authors: Felli Leonardo , Villas‐Boas J. Miguel
Published: January 2004

It has been argued that collusion among the members of an organization may lead to inefficiencies and hence should be prevented in equilibrium. This paper shows that whenever the parties to an organization can renegotiate their incentive scheme after collusion, these inefficiencies can be greatly reduced. Moreover, it might not be possible to prevent collusion and renegotiation in equilibrium. Indeed, if collusion is observable but not verifiable, then the organization's optimal incentive scheme will always be renegotiated. If, instead, collusion is not observable to the principal, both collusion and renegotiation will occur in equilibrium with positive probability. The occurrence of collusion and renegotiation should therefore not be taken as evidence of the inefficiency of an organization.
Incumbency and R&D Incentives: Licensing the Gale of Creative Destruction
Authors: Gans Joshua S. , Stern Scott
Published: January 2004

This paper analyzes the relationship between incumbency and R&D incentives in the context of a model of technological competition in which technologically successful entrants are able to license their innovation to (or be acquired by) an incumbent. That such a sale should take place is natural, since postinnovation monopoly profits are greater than the sum of duopoly profits. We identify three key findings about how innovative activity is shaped by licensing. First, since an incumbent's threat to engage in imitative R&D during negotiations increases its bargaining power, there is a purely strategic incentive for incumbents to develop an R&D capability. Second, incumbents research more intensively than entrants as long as (and only if) their willingness to pay for the innovation exceeds that of the entrant, a condition that depends critically on the expected licensing fee. Third, when the expected licensing fee is sufficiently low, the incumbent considers entrant R&D a strategic substitute for in‐house research. This prediction about the market for ideas stands in contrast to predictions of strategic complementarity in patent races where licensing is not allowed.
A Practitioner's Guide to Estimation of Random‐Coefficients Logit Models of Demand
Authors: Nevo Aviv
Published: January 2004

Estimation of demand is at the heart of many recent studies that examine questions of market power, mergers, innovation, and valuation of new brands in differentiated‐products markets. This paper focuses on one of the main methods for estimating demand for differentiated products: random‐coefficients logit models. The paper carefully discusses the latest innovations in these methods with the hope of increasing the understanding, and therefore the trust among researchers who have never used them, and reducing the difficulty of their use, thereby aiding in realizing their full potential.
Managerial Compensation and Capital Structure
Authors: Berkovitch Elazar , Israel Ronen , Spiegel Yossef
Published: January 2004

We investigate the interaction between financial structure and managerial compensation and show that risky debt affects both the probability of managerial replacement and the manager's wage if he is retained by the firm. Our model yields a rich set of predictions, including the following: (i) The market values of equity and debt decrease if the manager is replaced; moreover, the expected cash flow affirms that retain their managers exceeds that affirms that replace their managers, (ii) Managers affirms with risky debt outstanding are promised lower severance payments (golden parachutes) than managers affirms that do not have risky debt. (Hi) Controlling for firm's size, the leverage, managerial compensation, and cash flow of firms that retain their managers are positively correlated, (iv) Controlling for the firm's size, the probability of managerial turnover and firm value are negatively correlated, (v) Managerial pay‐performance sensitivity is positively correlated with leverage, expected compensation, and expected cash flows.
A Test of the Resource‐Based Model Using Baseball Free Agents
Authors: Poppo Laura , Weigelt Keith
Published: January 2004

This paper examines a nearly untested premise of the resource‐based view of the firm: managers can exploit uncertainty about a factor's true value to generate returns. Our results show that empirically validating this basic proposition is difficult and potentially impossible, despite our use of a rather simple empirical setting. While market imperfections appear to underlie the payment of baseball free agents, we cannot easily determine whether this imperfection constitutes a return or not. In addition, while we find convincing evidence of uncertainty underlying owner's expectations of a free agent's performance potential, it is not clear whether team owners can exploit this uncertainty by amassing superior informational strategies or investing in complementary assets. Our difficulty in testing resource‐based propositions suggests limitations to the theory's practicality.
Private Politics, Corporate Social Responsibility, and Integrated Strategy
Authors: Baron David P.
Published: January 2004

This paper provides a theory of private politics in which an activist seeks to change the production practices of a firm for the purpose of redistribution to those whose interests it supports. The source of the activist's influence is the possibility of support for its cause by the public. The paper also addresses the issue of corporate social responsibility by distinguishing among corporate redistribution as motivated by profit maximization, altruism, and threats by the activist. Private politics and corporate social responsibility not only have a direct effect on the costs of the firm, but also have a strategic effect by altering the competitive positions affirms in an industry. From an integrated‐strategy perspective the paper investigates the strategic implications of private politics and corporate social responsibility for the strategies of rival firms when one or both are targets of an activist campaign. Implications for empirical analysis are derived from the theory.
Theories of Strategic Nonmarket Participation: Majority‐Rule and Executive Institutions
Authors: Baron David P.
Published: January 2004

This paper presents theories of strategic nonmarket participation in majority‐rule and executive institutions and develops from those theories a set of principles for nonmarket strategy. The theories are based on models of vote recruitment in client and interest‐group politics and on models of common agency. The basic strategies developed are majority building, vote recruitment, agenda setting, rent‐chain mobilization, majority protection, and competitive agenda setting and vote recruitment.
The Institutional Environment for Telecommunications Investment
Authors: Henisz Witold J. , Zelner Bennet A.
Published: January 2004

This paper demonstrates that a structurally derived, internationally comparable index of checks and balances on executive discretion created by variation in political structures and party systems affects relative rates of basic telecommunications infrastructure deployment in 147 countries during the period 1960–1994. Models of infrastructure investment that omit the political characteristics of a prospective host country confound countries whose economic and demographic characteristics point to rapid demand growth for infrastructure services with those that create a potential trap for investors due to a higher probability of arbitrary change in the policy environment. The econometric analysis exploits both cross‐sectional and temporal variation in the panel. A robust covariance‐matrix estimator based on that developed by Newey and West is used to compute valid standard errors in the presence of heteroskedasticity and within unit‐serial correlation, two common characteristics in the error‐term structure of panel datasets.
Strategic Quality Decisions under Heterogeneous Resource Endowments
Authors: Rhee Byong‐Duk , Norton Seth W.
Published: January 2004

The literature on product competition advocates a differentiation strategy assuming firm homogeneity in resources. However, firm heterogeneity in resource endowments has long been recognized in economics. Merging these two perspectives, we show that the increase in consumer preference for quality leads to firms' aggressive price competition instead of quality differentiation. As consumers look for higher quality, the cost advantage arising from superior resources increases and makes head‐to‐head competition more profitable than accommodating a less efficient rival. When consumers are highly concerned about quality, even a small resource difference leads a more efficient firm to initiate cutthroat price competition for market dominance.
Vertical Integration and Proprietary Information Transfers
Authors: Hughes John S. , Kao Jennifer L.
Published: January 2004

Suppose that rival downstream producers of a final good contract with the same upstream supplier of an input and, in the process, reveal private information. A vertical merger between the upstream supplier and one of the downstream firms may dissipate the information advantage of the remaining downstream firms. The welfare consequences of such a merger and related information sharing depend on the value of information, the benefits of integration apart from information sharing, and the nature of upstream competition. In this paper, conditions are found under which owners of a vertically integrated firm are better off breaking up into independent firms. This result may explain AT&T's recent spinoff of Lucent Technologies. Further results suggest that a prohibition on information transfers, such as that often proposed by the Federal Trade Commission and Department of Justice as a precursor to approving vertical mergers, may actually reduce expected consumer surplus and expected social welfare.
On the Evolution of Overconfidence and Entrepreneurs
Authors: Bernardo Antonio E. , Welch Ivo
Published: January 2004

This paper explains why seemingly irrational overconfident behavior can persist. Information aggregation is poor in groups in which most individuals herd. By ignoring the herd, the actions of overconfident individuals (“entrepreneurs”) convey their private information. However, entrepreneurs make mistakes and thus die more frequently. The socially optimal proportion of entrepreneurs trades off the positive information externality against high attrition rates of entrepreneurs, and depends on the size of the group, on the degree of overconfidence, and on the accuracy of individuals' private information. The stationary distribution trades off the fitness of the group against the fitness of overconfident individuals.
Optimal Money Burning: Theory and Application to Corporate Dividends
Authors: Bernheim B. Douglas , Redding Lee S.
Published: January 2004

We explore signaling behavior in settings with a discriminating activity and several costly nondiscriminating (“money‐burning”) activities. Existing theory provides no basis for selecting one method of burning money over another. When senders have better information about activity costs than receivers, each sender's indifference is resolved, the taxation of a money‐burning signal is potentially Pareto‐improving, and the use of the taxed activity becomes more widespread as the tax rate rises. We apply this theory to dividend signaling. Its central testable implication—that an increase in the dividend tax increases the likelihood of dividend payout—is verified empirically.
The Strategic Effects of Vertical Market Structure: Common Agency and Divisionalization in the US Motion Picture Industry
Authors: Corts Kenneth S.
Published: January 2004

I examine the release‐date scheduling of all motion pictures that went into wide release in the US in 1995 and 1996 to investigate the effects of vertical market structure on competition. The evidence suggests that complex vertical structures involving multiple upstream or downstream firms generally do not achieve efficient outcomes in movie scheduling. In addition, analysis of the data suggests that the production divisions of the major studios act as integrated parts of the studio, rather than as independent competing firms.
Asymmetric Information, Bargaining, and International Mergers
Authors: Das Satya P. , Sengupta Sarbajit
Published: January 2004

The formation of international mergers is examined in the presence of two kinds of asymmetric information, one when a local firm has private information on market size and the other when a foreign firm has private information on its technology. In each situation, parametric configurations are identified under which a merger offer may or may not be made. It also examines the kind of offer and the probability of its acceptance. The likelihood of a merger beingformed is also related to the basic market size, demand uncertainty, and cost uncertainty. Welfare effects of tax/subsidy policies by the host country are also analyzed.
Price Competition and Advertising Signals: Signaling by Competing Senders
Authors: Hertzendorf Mark N. , Overgaard Per Baltzer
Published: January 2004

Can price and advertising be used by vertically differentiated duopolists to signal qualities to consumers? We show that pure price separation is impossible if the vertical differentiation is small, while adding dissipative advertising ensures the existence of separating equilibria. Two simple, but nonstandard, equilibrium refinements are introduced to deal with the multisender nature of the game, and they are shown to produce a unique separating and a unique pooling profile. Pooling results in a zero‐profit Bertrand outcome. Separation gives strictly positive duopoly profits, and dissipative advertising is used by the high‐quality firm when products are sufficiently close substitutes. Finally, compared to the complete‐information benchmark, the separating prices of both firms are distorted upwards when the degree of vertical differentiation is large, and downwards when it is small.
Network Incentives in Managed Health Care
Authors: Albert Ma Ching‐To , Mcguire Thomas G.
Published: January 2004

This paper introduces a theory of network incentives in managed health care. Participation in the plan's network confers an economic benefit on providers; in exchange, the plan expects compliance with its protocols. The network sets a target for the number of outpatient visits in an episode of care. A provider failing to satisfy the target may be penalized by the plan's attempt to direct patients to other providers within its network. There is an equilibrium in which every provider in the network uses the target. We test the theory by observing behavior of providers before and after the introduction of managed mental health care in a large, employed population. Managed care consisted of price reductions, utilization review, and creation of a network. Quantity per episode of care fell sharply after initiation of managed care. We identify a network effect in our empirical work. The results indicate that in this case, network incentives account for most of the quantity reduction due to managed care.
Horizontal Integration Between Brand and Generic Firms in the Pharmaceutical Industry
Authors: Morton Fiona M. Scott
Published: January 2004

This paper asserts that brand pharmaceutical firms (those mostly involved in the invention and production of new drugs) engage in a set of complementary activities that are different from those of generic pharmaceutical firms (those that primarily make off‐patent medicines). Complementarities of the Milgrom‐Roberts variety within, but not across, these two kinds of firms make it more efficient for pharmaceutical firms to specialize in either brand or generic production. Using FDA data, I show that this is indeed the case. I then examine the firms that produce both types of drugs to see if there are market‐level strategic synergies between brand and generic products. I find generic entrants that belong to a corporation that owns the brand in the market are (1) not more likely to enter, (2) not more likely to be approved faster, and (3) not more likely to deter other generics from entering. Thus the advantage, or synergy, from mixing brand and generic activities in one corporation must arise elsewhere in the operations of the firm. If not, the integrated pharmaceutical firm is not the most efficient organizational form for the production of ethical drugs.