Showing papers in "The RAND Journal of Economics in 1994"

Estimating Discrete-Choice Models of Product Differentiation

Abstract: This article considers the problem of "supply-and-demand" analysis on a cross section of oligopoly markets with differentiated products. The primary methodology is to assume that demand can be described by a discrete-choice model and that prices are endogenously determined by price-setting firms. In contrast to some previous empirical work, the techniques explicitly allow for the possibility that prices are correlated with unobserved demand factors in the cross section of markets. The article proposes estimation by "inverting" the market-share equation to find the implied mean levels of utility for each good. This method allows for estimation by traditional instrumental variables techniques.

The Importance of Patent Scope: An Empirical Analysis

Abstract: This article examines the impact of patent scope on firm value. I develop a proxy for patent scope based on the International Patent Classification scheme. Using a sample of 535 financing rounds at 173 privately held venture-backed biotechnology firms. I show that the breadth of patent protection significantly affects valuations. A one standard deviation increase in average patent scope is associated with a 21% increase in the firm's value. Broad patents are more valuable when substitutes in the same product class are plentiful, a finding consistent with theoretical suggestions.

Entrepreneurial Decisions and Liquidity Constraints

Abstract: Using a matched sample of federal estate and personal income tax returns, we examine how the receipt of an inheritance affects an individual's decision to become an entrepreneur and the amount of capital employed in the new enterprise. These findings are consistent with the presence of liquidity constraints.

Hedonic Price Indexes for Spreadsheets and an Empirical Test for Network Externalities

Abstract: In this article, I first estimate hedonic price equations for computer spreadsheet programs, and then use the analysis to empirically test whether network externalities exist in this industry. The study shows that consumers are willing to pay a significant premium for spreadsheets that are compatible with the Lotus platform and for spreadsheets that offer links to external databases, and a similar premium for spreadsheets that offer local area network externalities. Finally, the quality-adjusted (real) price of computer spreadsheets declined by approximately 15% per year from 1986 to 1991.

Computing markov-perfect nash equilibria: numerical implications of a dynamic differentiated product model

Abstract: This paper provides an algorithm for computing Markov Perfect Nash Equilibria (Maskin and Tirole, 1988a and b) for dynamic models that allow for heterogeneity among firms and idiosyncratic (or firm specific) sources of uncertainty. It has two purposes. To illustrate the ability of such models to reproduce important aspects of reality, and to provide a tool which can be used for both descriptive and policy analysis in a framework rich enough to capture many of the features of firm level data sets (thereby enabling it to be integrated with the empirical detail in those data sets). We illustrate by computing the policy functions, and simulating the industry structures, generated by a class of dynamic differentiated product models in which the idiosyncratic uncertainty is due to the random outcomes of each firm's research process (we also allow for an autonomous aggregate demand process). The illustration focuses on comparing the effects of different regulatory and institutional arrangements on market structure and on welfare for one particular set of parameter values. The simulation results are of independent interest and can be read without delving into the technical detail of the computational algorithm The last part of the paper begins with an explicit consideration of the computational burden of the algorithm, and then introduces approximation techniques designed to make computation easier. This section provides some analytic results which dramatically reduce the computational burden of computing equilibria for industries in which a large number of firms are typically active.

Acquisition and Disclosure of Information Prior to Sale

Abstract: This article analyzes incentives to acquire information about the value of things before sales transactions, and voluntary versus required disclosure of such information. Two distinctions are emphasized: whether information is mere foreknowledge or instead can raise value -- has social value; and whether it is sellers or buyers who decide to acquire information. The main conclusions in the model are that voluntary disclosure results in socially excessive incentives to acquire information; mandatory disclosure is socially desirable for sellers; but for buyers, the freedom to keep silent may be needed to spur acquisition of socially desirable information.

Honesty and Evasion in the Tax Compliance Game

Abstract: Conventional models of tax compliance emphasize that taxpayers make strategic tax reports, underreporting income to the extent that this behavior is functionally rewarded. In contrast to this view, considerable empirical evidence suggests that many taxpayers are inherently honest, reporting truthfully regardless of the incentive to cheat. In this article we build a game-theoretic model of tax compliance that includes both honest and potentially dishonest taxpayers. We show that including honest taxpayers significantly alters the model, leading to much improved empirical predictions and somewhat different and novel policy implications.

Theories of Cartel Stability and the Joint Executive Committee

Abstract: This article reexamines the experience of the Joint Executive Committee, an 1880s railroad cartel, to assess the applicability of the Green and Porter (1984) and Rotemberg and Saloner (1986) theories of price wars. After discussing necessary modifications to the theories, I estimate a number of dynamic models to explore the causes of price wars, the cyclical nature of pricing, and the possibility that secret price cuts may have been given. The estimates provide some support for the predictions of the first theory.

Capacity constraints and cycles in property casualty insurance markets

Abstract: Underwriting cycles are unexpected in a structurally competitive industry where financial capital is the major determinant of output capacity. "Arbitrage" theories explain underwriting cycles as largely an artifact of institutional lags and reporting practices: "capacity-constraint" theories view insurance markets as characterized by real frictions that cause underwriting cycles by temporarily reducing the industry's capacity to insure risks. Arbitrage theories imply nofsystematic relationship between capacity and underwriting margins, while capacity-constraint hypotheses predict a negative relationship. This article provides a test of the two theories by examining the empirical relationship between caSacity and underwriting margins. The results, using data on four insurance lines, generally support the capacity-constraint hypothesis; unanticipated decreases in capacity cause higher profitability and prices.

How hospital ownership affects access to care for the uninsured.

Abstract: This article addresses the effect of hospital ownership on the delivery of service to uninsured patients. It compares the volume of uninsured patients treated in for-profit and nonprofit hospitals by regarding hospital ownership and service as endogenous. Instrumental variable estimates are used to predict the percentage of patients who are uninsured, controlling for hospital ownership and service. The study shows that when for-profit and nonprofit hospitals are located in the same area, they serve an equivalent number of uninsured patients, but for-profit hospitals indirectly avoid the uninsured by locating more often in better-insured areas.

Plant Age and Technology use in U.S. Manufacturing Industries

Abstract: In this article, I use a new dataset on advanced technology usage in U.S. manufacturing plants to describe how technology use varies by plant age and size. The data come from the 1988 Survey of Manufacturing Technology (SMT) and cover a wide range of technologies and a large group of fabrication and assembly industries. Both old and young plants appear to use advanced manufacturing technology at similar frequencies. As in previous studies, I find that larger plants are more likely to employ newer technologies than are smaller plants.

News Management and the Value of Firms

Abstract: The literature on asymmetric information has been concerned mainly with the problem of the informed party lying to the uninformed parties. However, in many cases, the informed party will stop short of lying but will seek to gain from private information by managing the disclosure of news. This article examines the pricing of a firm when there is such manipulation of news. I model this situation as a variant of the "persuasion game" of Milgrom and Roberts (1986) in which I can parameterize the notion of the degree of credence placed by the market on the disclosures of the informed party . An empirical hypothesis thrown up by the theory is that for otherwise identical firms, a low price/earnings ratio will be associated with a greater degree of positive skewness of the disclosure strategy.

The Dynamic Efficiency of Regulatory Constitutions

Abstract: In this article, we model regulation as a repeated game between a utility facing a random sequence of demands and a regulator tempted to underreward past investment. Rate-of-return regulation designed with a constitutional commitment to an adequate rate of return on capital prudently invested is able to support an efficient investment program as a subgame-perfect Nash equilibrium for a larger set of parameter values than rate-of-return regulation without such a commitment. Furthermore, rate-of-return regulation is superior to price regulation according to the same criterion, assuming that the regulator is unable to make state-contingent transfer payments.

Do Important Drugs Reach the Market Sooner

Abstract: Since the Food and Drug Administration (FDA) Amendments of 1962, the average time from a drug's first worldwide patent application to its approval by the FDA has risen from 35 to 135 years FDA policies and manufacturers' incentives suggest that more important drugs may have reached the market sooner To test this, we develop measures of "time to approval" and "importance," and determine how the latter affects the former Our results indicate that more important drugs are developed and approved more rapidly than less important drugs These results imply that the costs of approval lags have probably been overstated and challenge estimates of the returns to research and development in the pharmaceutical industry

The capital structure of a regulated firm

Abstract: We examine the equilibrium price, investment, and capital structure of a regulated firm using a sequential model of regulation. We show that the firm's capital structure has a significant effect on the regulated price. Consequently, the firm chooses its equity and debt strategically to affect the outcome of the regulatory process. In equilibrium, the firm issues a positive amount of debt and the likelihood of bankruptcy is positive. Debt raises the regulated price, thus mitigating regulatory opportunism. However, underinvestment due to lack of regulatory commitment to prices persists in equilibrium.

Inventories and the short-run dynamics of commodity prices

Abstract: Supported by M.I.T.'s Center for Energy Policy Research. Supported by the National Science Foundation.

On the Existence of Predatory Pricing: An Experimental Study of Reputation and Entry Deterrence in the Chain-Store Game

Abstract: A single monopolist plays a sequence of eight periods against a series of different entrants. There are two types of monopolists, "weak" monopolists whose single-period best response is to acquiesce after entry, and "strong" monopolists whose dominant strategy is to fight entry. Data show high levels of predatory pricing, defined as weak monopolists fighting all entrants in early periods, both with and without experimenter-induced strong monopolists. We reject a number of predictions of the asymmetric-information, sequential equilibrium model of Kreps and Wilson (1982) and find important deviations from more general sequential equilibrium models as well.

Double Moral Hazard and Resale Price Maintenance

Abstract: Incentives for resale price maintenance (RPM) are studied in a wholesaler-retailer relationship in which both firms make a nonprice choice subject to moral hazard. The best attainable contract has vertical externalities in both nonprice choices and the choice of consumers' price if delegated to the retailer. RPM controls the latter externality but interacts with the other externalities as well. As a consequence, either minimum or maximum vertical price fixing can be optimal in spite of a successive-monopoly specification. Similar incentives exist for writing other variables into contract, such as the capital input of the retailer.

Pretrial Bargaining and the Design of Fee-Shifting Rules

Abstract: Legal rules for allocating the private costs of civil litigation, or "fee-shifting" rules, provide powerful incentives for settlement. Within the context of a direct-revelation mechanism, the fee-shifting rule that generates the highest probability of settlement bases the allocation of costs upon the proximity of the court's award to the pretrial announcements. This mechanism resembles Rule 68 of the Federal Rules of Civil Procedure and other offer-based rules. In a simple extensive-form game, if the litigants have asymmetric information about the level of damages (probability of prevailing), then Rule 68 increases (decreases) the settlement rate.

Irreversible choice of uncertain technologies with network externalities

Abstract: In this article, I explore the problem of sequential and irreversible technology choice in the presence of network externalities when the technologies stochastically evolve over time. Early potential users are shown to adopt an irreversible technology too early compared to the social optimum. The effect of increasing the uncertainty of the technologies on an early potential user's decision is analyzed. I find that the sponsor of new emerging technology might choose a research strategy that is too safe. I also study the consequences of allowing side payments between generations of consumers and demonstrate that an ex post optimal standardization policy can impair ex ante social welfare.

The Determinants of Efficiency and Solvency in Savings and Loans

Abstract: We study the efficiency and solvency of savings and loans institutions (thrifts). Thrifts that were inefficient (according to a nonparametric measure) were 4 1/2 times more likely than efficient thrifts to fail in the future. We also find that absent controls for lines of business pursued, stock institutions were both less efficient and more likely to fail than mutuals. With controls, these results are reversed. A consistent explanation is that stock institutions are better at resolving the standard agency conflict between owners and managers, but worse at resolving the "asset-substitution" conflict between shareholders and debtholders (depositors). Last, we find that some lines of business deregulated by the Garn-St. Germain Act adversely affected efficiency and solvency.

Heterogeneity in Organizational Form: Why Otherwise Identical Firms Choose Different Incentives for Their Managers

Abstract: Product-market competition affects the benefits from providing incentives to managers. In particular, the best response to other firms providing strong incentives can be to provide weak incentives. Conversely, the best response to other firms providing weak incentives can be to provide strong incentives. In equilibrium only a fraction of the firms may, therefore, provide strong incentives. Moreover, all equilibria may exhibit heterogeneity in incentives due to the nonconvexities inherent in the underlying agency problem between firms and their managers. This article also investigates how increased competition affects the strength of the incentives provided in the equilibrium.

Mortality Effects of Regulatory Costs and Policy Evaluation Criteria

Abstract: This article concerns the cost benefit of policies designed to reduce risks of mortality in specific instances. The author points out that "risk regulations directly reduce risk but they may produce offsetting risk increases. Regulated risks generate a substitution effect as individuals risk-averting actions will diminish. Recognition of these effects alters benefit-cost criteria and the value-of-life estimates pertinent to policy analysis. Particularly expensive risk regulations may be counterproductive. The expenditure level that will lead to the loss of one statistical life equals the value of life divided by the marginal propensity to spend on health. Regulations with a cost of $30 million to $70 million per life saved will on balance have a net adverse effect on mortality because of these linkages." (EXCERPT)

Learning by Doing and Competition in the Early Rayon Industry

Abstract: In this article I derive a structural econometric model of learning by doing from a dynamic oligopoly game. Unlike previous empirical models, this model is capable of testing hypotheses concerning both the technological nature and strategic implications of learning. I estimate the model with firm-level data from the early U.S. rayon industry. The empirical results show that there were considerable differences across firms in both proprietary and spillover learning. The results also indicate that the two leading firms took their rival's reactions into account when choosing their strategies.

Market Power and Mergers in Laboratory Markets with Posted Prices

Abstract: In this article, we use laboratory methods to evaluate determinants of supracompetitive pricing. The experiment involves three treatments, each with the same market supply, demand, and competitive price. In the baseline treatment, capacity is divided among five sellers so that the competitive price is a Nash equilibrium. Market power is created in a second treatment by reallocating capacity among the sellers. This market power raises observed prices in all sessions. In a third treatment, the three smallest sellers are merged in a way that holds market power constant. The consolidation has little residual effect on prices.

Service time competition

Abstract: How can two physically identical gasoline stations differentiate themselves? In this article we develop and test a model of service time competition: some stations set higher prices and thereby offer shorter queues, whereas others offer lower price and longer queues. We find that retail demand is sensitive to service time: customers are, on average, willing to pay about 1% more for a 6% reduction in congestion. Consistent with the service time hypothesis, prices are more dispersed at stations facing more direct competition.

Optimal Retail Contracts with Asymmetric Information and Moral Hazard

Abstract: Constrained joint-profit-maximizing retail contracts are derived when the dealer is privately informed about demand conditions before contracting with the manufacturer. Demand is increased by dealer promotion, which is unobservable by the manufacturer. Consequently, the manufacturer does not know whether to attribute a low level of sales to a decline in demand or to a lack of promotion. We show that, in general, the optimal contract exhibits some form of resale price maintenance and quantity fixing. The type of resale price maintenance and quantity fixing depends on how price and quantity affect the link between sales and promotion.

Optional Time-of-Use Prices for Electricity: Econometric Analysis of Surplus and Pareto Impacts

Abstract: We estimate a model of time-of-use (TOU) consumption and choice among optional TOU tariffs in which the customer's choice among tariffs is based on its demand parameters, which vary in the population. We simulate the impact on consumption, consumer surplus, and profit of several optional TOU rates that were offered experimentally in northern California. The analysis suggests that, with one possible exception, the offering of these optional rates did not constitute a Pareto improvement. However, total surplus, excluding measurement costs, is estimated to have risen by $1.41 to $2.55 per month per customer who chose the TOU rates.

Price and quality cycles for experience goods

Abstract: We explore a dynamic, competitive model for experience goods and study an equilibrium for it in which firms plan initially to produce high quality at low price, then high quality at high price, then low quality at high price. Each consumer is aware that all firms eventually intend to run down their reputations at customers' expense, yet he rationally chooses to wait for direct evidence that the firm to which he is attached has already entered into the exploitative phase.

Dynamic duopoly with best-price clauses

Abstract: This article investigates best-price clauses as a strategic devise to facilitate collusion in a dynamic duopoly game. Best-price clauses guarantee rebates on the purchase price if a customer finds a better price after his purchase. Two different price clauses are distinguished: "most favored customer" and "meet or release." I examine the collusive potential of both clauses in a finite-horizon duopoly model with homogeneous durable goods. In each period, new consumers enter the market. I show that in this context, meet-or-release clauses have a greater anticompetitive potential than most-favored-customer clauses.