Showing papers in "The RAND Journal of Economics in 2010"

Computable Markov‐perfect industry dynamics

Abstract: We provide a general model of dynamic competition in an oligopolistic industry with investment, entry,andexit.ToensurethatthereexistsacomputationallytractableMarkov-perfectequilibrium, we introduce firm heterogeneity in the form of randomly drawn, privately known scrap values and setup costs into the model. Our game of incomplete information always has an equilibrium in cutoff entry/exit strategies. In contrast, the existence of an equilibrium in the Ericson and Pakes’ model of industry dynamics requires admissibility of mixed entry/exit strategies, contrary to the assertion in their article, that existing algorithms cannot cope with. In addition, we provide a condition on the model’s primitives that ensures that the equilibrium is in pure investment strategies. Building on this basic existence result, we first show that a symmetric equilibrium exists under appropriate assumptions on the model’s primitives. Second, we show that, as the distribution of the random scrap values/setup costs becomes degenerate, equilibria in cutoff entry/exit strategies converge to equilibria in mixed entry/exit strategies of the game of complete information.

State Dependence and Alternative Explanations for Consumer Inertia

Abstract: For many consumer packaged goods products, researchers have documented inertia in brand choice, a form of persistence whereby consumers have a higher probability of choosing a product that they have purchased in the past. Using data on margarine and refrigerated orange juice purchases, we show that the finding of inertia is robust to flexible controls for preference heterogeneity and not due to autocorrelated taste shocks. Thus, the inertia is at least partly due to structural, not spurious state dependence. We explore three economic explanations for the observed structural state dependence: preference changes due to past purchases or consumption experiences which induce a form of loyalty, search, and learning. Our data are consistent with loyalty, but not with search or learning. Properly distinguishing among the dierent sources of inertia is important for policy analysis, because the alternative sources of inertia imply qualitative dierences in firm’s pricing incentives and lead to quantitatively dierent equilibrium

The dynamics of the transfer and renewal of patents

Abstract: This article explores new data on the transfer and renewal of U.S. patents and interprets this new evidence using a model of patent transfers and renewal. We find that the proportion of transferred patents is large and differs across technology fields and especially type of patentees. We also find that the probability of a patent being traded depends on a number of factors—the age of the patent, the number of citations received by a given age, the patent generality, and whether the patent has been previously traded or not. These findings are consistent with the predictions of a model of patent transfers and renewals.

Net neutrality and investment incentives

Abstract: This paper analyzes the effects of net neutrality regulation on investment incentives for Internet service providers (ISPs) and content providers (CPs), and their implications for social welfare. We show that the ISP's decision on the introduction of discrimination across content depends on a potential trade-off between network access fee and the revenue from the trade of the first-priority. Concerning the ISP's investment incentives, we find that capacity expansion affects the sale price of the priority right under the discriminatory regime. Because the relative merit of the first priority, and thus its value, becomes relatively small for higher capacity levels, the ISP's incentive to invest on capacity under a discriminatory network can be smaller than that under a neutral regime where such rent extraction effects do not exist. Contrary to ISPs' claims that net neutrality regulations would have a chilling effect on their incentive to invest, we cannot dismiss the possibility of the opposite. Classification-JEL: D4, L12, L4, L43, L51, L52

Inference on Vertical Contracts between Manufacturers and Retailers Allowing for Nonlinear Pricing and Resale Price Maintenance

Abstract: We present a model of vertical contracts between manufacturers and retailers with nonlinear pricing strategies. Using home-scan data on bottled water produced by manufacturers and sold by retail chains in France, we estimate a structural demand and supply model allowing for two-part tariff contracts between manufacturers and retailers. Using price-cost margins recovered from estimates of demand parameters, we select the best supply model by performing nonnested tests, and find that manufacturers use two-part tariff contracts with resale price maintenance. We then perform counterfactual policy simulations that restrict the use of these vertical contracts and assess welfare effects under alternative scenarios.

Does vertical integration affect firm performance? Evidence from the airline industry

Abstract: We investigate the effects of vertical integration on operational performance. Large U.S. airlines use regional partners to operate some of their flights. Regionals may be owned or governed through contracts. We estimate whether an airline’s use of an owned, rather than independent, regional at an airport affects delays and cancellations on the airline’s own flights out of that airport. We find that integrated airlines perform systematically better than nonintegrated airlines at the same airport on the same day. Furthermore, the performance advantage increases on days with adverse weather and when airports are more congested. These findings suggest that, in this setting, vertical integration may facilitate real-time adaptation decisions.

The Effects of Mergers on Product Positioning: Evidence from the Music Radio Industry

Abstract: This article shows that mergers between close competitors in the music radio industry lead to important changes in product positioning. Firms that buy competing stations tend to differentiate them and, consistent with the firm wanting to reduce audience cannibalization, their combined audience increases. However, the merging stations also become more like competitors, so that aggregate variety does not increase, and the gains in market share come at the expense of other stations in the same format. The results shed light on the effects of mergers and, more broadly, how multi-product firms may use product positioning as a competitive tool.

Patent thickets, courts, and the market for innovation

Abstract: We study how fragmentation of patent rights and the formation of the Court of Appeals for the Federal Circuit (CAFC) affected the duration of patent disputes, and thus the speed of technology diffusion through licensing. We develop a model of patent litigation which predicts faster settlement when patent rights are fragmented and when there is less uncertainty about court outcomes, as was associated with the “pro-patent shift” of the CAFC. We confirm these predictions empirically using a data set that covers patent suits in U.S. district courts during the period 1975–2000. Finally, we analyze how fragmentation affects total settlement delay, considering both the reduction in dispute duration and the increase in the number of patent negotiations.

On the origin of shared beliefs (and corporate culture)

Abstract: This article shows how corporate culture, in the sense of shared beliefs and values, originates (often unintentionally) through screening, self-sorting, and manager-directed joint learning. It shows that such culture will be stronger among more important employees and in older and more successful firms where employees make important decisions and the manager has strong beliefs. It further shows how a manager’s beliefs influence culture, how culture persists despite turnover, and why the suggested link between culture and performance may be a case of inverse causality. It finally shows that, from an outsider’s perspective, organizations may tend to overinvest in corporate culture.

Procurement when price and quality matter

Abstract: A buyer seeks to procure a good characterized by its price and its quality from suppliers who have private information about their cost structure ( xed cost and marginal cost of providing quality). We characterize the buyer’s optimal buying mechanism. We then use the optimal mechanism as a theoretical and numerical benchmark to study simpler buying procedures such as scoring auctions and bargaining. Scoring auctions can extract a signifi cant proportion of the buyer’s strategic surplus (the difference between the expected utility from the optimal mechanism and the e¢ cient auction). Bargaining does less well and often does worse than the e¢ cient auction.

Endogenous cartel formation with heterogeneous firms

Abstract: In the context of an infinitely repeated capacity-constrained price game, we endogenize the composition of a cartel when firms are heterogeneous in their capacities. When firms are sufficiently patient, there exists a stable cartel involving the largest firms. A firm with sufficiently small capacity is not a member of any stable cartel. When a cartel is not all-inclusive, colluding firms set a price that serves as an umbrella with non-cartel members pricing below it and producing at capacity. Contrary to previous work, our results suggest that the most severe coordinated effects may come from mergers involving moderate-sized firms, rather than the largest or smallest firms.

Standard promotion practices versus up‐or‐out contracts

Abstract: This article develops a theory concerning the choice between standard promotion practices and up-or-out contracts. Our theory is based on asymmetric learning and promotion incentives. We find that firms employ up-or-out contracts when firm-specific human capital is low and standard promotion practices when it is high. We also find that, if commitment to a wage floor is feasible and effort provision is important, up-or-out is employed when low- and high-level jobs are similar. These results are consistent with many of the settings in which up-or-out is typically observed, such as law firms and academia.

Dynamic pricing: when to entice brand switching and when to reward consumer loyalty

Abstract: This article develops a theory of dynamic pricing in which firms may offer separate prices to different consumers based on their past purchases. Brand preferences over two periods are described by a copula admitting various degrees of positive dependence. When commitment to future prices is infeasible, each firm offers lower prices to its rival's customers. When firms can commit to future prices, consumer loyalty is rewarded if preference dependence is low, but enticing brand switching occurs if preference dependence is high. Our theory provides a unified treatment of the two pricing policies and sheds light on observed practices across industries.

Competition for scarce resources

Abstract: We model a downstream industry where firms compete to buy capacity in an upstream market which allocates capacity efficiently. Although downstream firms have symmetric production technologies, we show that industry structure is symmetric only if capacity is sufficiently scarce. Otherwise it is asymmetric, with one large, “fat,” capacity-hoarding firm and a fringe of smaller, “lean,” capacity-constrained firms. As demand varies, the industry switches between symmetric and asymmetric phases, generating predictions for firm size and costs across the business cycle. Surprisingly, increasing available capacity can cause a reduction in output and consumer surplus by resulting in such a switch.

Do Americans consume too little natural gas? An empirical test of marginal cost pricing

Abstract: A standard result in regulation is that efficiency requires that marginal prices be set equal to marginal costs. This paper performs an empirical test of marginal cost pricing in the natural gas distribution market in the United States during the period 1989-2008. For all 50 states we reject the null hypothesis of marginal cost pricing. Departures from marginal cost pricing are particularly severe in residential and commercial markets, where we find average markups of over 40%. Based on conservative estimates of the price elasticity of demand these distortions impose hundreds of millions of dollars of annual welfare loss. Moreover, the current pricing schedules are an important pre-existing distortion which should be taken into account when evaluating carbon taxes and other policies aimed at addressing external costs. Current markups for residential and commercial customers are already equivalent to a tax of over $200 per metric ton of carbon, considerably higher than the range envisioned by most economists.

Bribery versus extortion: allowing the lesser of two evils

Abstract: Both bribery and extortion weaken the power of incentives, but there is a trade-off in fighting the two because rewards to prevent supervisors from accepting bribes create incentives for extortion. Which is the worse evil? A fear of inducing extortion may make it optimal to tolerate bribery, but extortion is never allowed. Extortion discourages good behavior because the agent suffers from it even though he has done the right thing, whereas a bribe acts as a penalty for bad behavior. Our analysis provides lessons to fight corruption and explanations why developed countries may have an advantage in dealing with extortion. © 2010, RAND.

The effect of satellite entry on cable television prices and product quality

Abstract: How has the entry of satellite television affected the pricing and product quality of incumbent cable firms' programming packages? I estimate a model in which firms compete over both price and product quality (as determined by what channels are offered). Satellite entry typically causes cable firms to raise quality and lower price. However, in some markets, cable optimally responds by raising both price and quality or by lowering both price and quality. A counterfactual scenario that eliminates quality competition results in, on average, softer price competition and lower aggregate consumer surplus, but greater surplus for consumers with weaker preferences for quality.

Natural concentration in industrial research collaboration

Abstract: Empirical work suggests that the network of research and development alliances is asymmetric, with a small number of firms involved in the majority of partnerships. This paper relates the structure of the collaboration network to a fundamental characteristic of the demand for research output: the benefits of knowledge accumulation create private and social incentives for a concentration of collaborative activities. I theoretically investigate the formation of bilateral collaborative links in two different industry settings, one socially managed, the other oligopolistic. I find that in both cases a concentrated network is the typical equilibrium structure as well as the socially efficient structure.

Inferring market power under the threat of entry: the case of the Brazilian cement industry

Abstract: Consider a setting where threatened rather than actual import competition restrains a domestic oligopoly's prices. I show that not modelling the entry threat may underestimate the true degree of market power, as incumbents' blunted price responses to demand shocks resemble perfectly competitive behavior. Evidence from Brazilian cement markets points to an important role for imports in determining domestic cement prices, despite the near absence of imports. On assuming autarky, models with market power are rejected in favor of competition among incumbents. However, allowing a role for imports rejects the autarky assumption and precludes one from rejecting the presence of market power.

Market-share contracts as facilitating practices

Abstract: This article investigates how the use of contracts that condition discounts on the share a supplier receives of a retailer's total purchases (market-share contracts) may affect market outcomes. The case of a dominant supplier that distributes its product through retailers that also sell substitute products is considered. It is found that when the supplier's contracts can only depend on how much a retailer purchases of its product (own-supplier contracts), intra- and interbrand competition cannot simultaneously be dampened. However, competition on all goods can simultaneously be dampened when market-share contracts are feasible. Compared to own-supplier contracts, the use of market-share contracts increases the dominant supplier's profit and, if demand is linear, lowers consumer surplus and welfare.

Leadership based on asymmetric information

Abstract: Rational players, unconstrained by contracts or formal authority, choose to follow a better-informed leader, whose action reveals part of her information. If the leader satisfies a credibility condition, then the unique nondegenerate equilibrium solves distinct shirking and coordination problems and achieves the first best. If credibility fails, as is more likely for a large organization, then followers ignore the leader, and equilibria are very inefficient. Appointing multiple leaders, or a high-cost leader, can restore credibility. If players invest privately in information, then a leader often appears endogenously. The equilibrium concept is an original extension of sequential equilibrium to continuous states.

Transparency and incentives among peers

Abstract: This article studies the effect of transparency among peers on the principal's cost of providing incentives. Using directed graphs to represent peer information, we show that under complementarity the cost of providing incentives is decreasing with the level of transparency within the organization. We also investigate the role of the architecture of the information in boosting incentives. In arguing that substitution impedes the benefits of transparency, we will compare function-based teams with process-based teams, showing that the latter are more effective in providing incentives. © 2010, RAND.

Trigger happy or gun shy? Dissolving common‐value partnerships with Texas shootouts

Abstract: The operating agreements of many business ventures include clauses to facilitate the exit of joint owners. In so-called Texas Shootouts, one owner names a single buy-sell price and the other owner is compelled to either buy or sell shares at that named price. Despite their prevalence in real-world contracts, Texas Shootouts are rarely triggered. In our theoretical framework, sole ownership is more efficient than joint ownership. Negotiations are frustrated, however, by the presence of asymmetric information. In equilibrium, owners eschew buy-sell offers in favor of simple offers to buy or to sell shares and bargaining failures arise. Experimental data support these findings.

Specialization and matching in professional services firms

Abstract: Economic theory indicates that firms can match workers to jobs and promote productivity-enhancing specialization better than markets, yet few data exist. We empirically test whether firms enhance matching and specialization in the context of obstetrics. We then examine whether consumers benefit from this. We find that high-risk patients in group practices match with specialists more than patients of solo physicians, and this improves patients’ health outcomes. Matching based on a patient’s clinical need for a cesarean section delivery and a physician’s cesarean section skill also occurs, but less extensively. These results support the hypothesis that firms facilitate matching and specialization.

First-price auctions with resale and with outcomes robust to bid disclosure

Abstract: Although there exists a pure separating equilibrium of the two-bidder first-price auction with resale when the bids are kept secret, the ratchet effect prevents the existence of such an equilibrium if the bidders are heterogeneous and the bids are fully disclosed. Nevertheless, we construct a behavioral equilibrium under full disclosure that is equivalent to the pure separating equilibrium under no disclosure. Thus, if the bidders follow this equilibrium, the choice of the disclosure regime does not affect the final allocation of the item nor the expected payoffs.

Information and delay in an agency model

Abstract: Negotiations often take long time even if a delay in the agreement is inefficient. One typical explanation is the existence of private information of at least one party; the time is then a discriminating instrument. The paper starts by pointing out that this result does not hold once the traded quantity is not fixed as in most bargaining models; the quantity outperforms the time as a discriminating instrument, that is, there is no delay. Moreover, Coase conjecture does not hold either. We then study how a signal arriving in the course of negotiations affects the delay in the agreement. Unlike investment-under-uncertainty models, a better signal not only improves contracting in the future but also in the present. Therefore, the delay is in general not monotonic in the quality of information. The value of information can be negative over some range as better information may aggravate the principal’s commitment problem.

Shareholder Access to Manager-Biased Courts and the Monitoring/Litigation Trade-Off

Abstract: Facilitating access to courts for outside shareholders is often viewed as a remedy against managerial opportunism. My model shows that, when courts are biased toward managers, reducing the barriers to shareholder suits can lower efficiency because it can lead to either excessive litigation or excessive monitoring of managers by shareholders. The latter effect implies that easy shareholder litigation may lead to a greater use of substitute mechanisms of corporate governance rather than more reliance on the judiciary. I also show that easy shareholder access to manager-biased courts leads to the formation of more, rather than less, concentrated ownership structures.

Monopolistic Screening under Learning By Doing

Abstract: This article investigates the design of incentives in a dynamic adverse selection Framework where agents' production technologies display learning effects and agents' learning rates are private knowledge. In a simple two-period model with full commitment available to the principal we show that whether learning effects are over- or underexploited crucially depends on whether more effcient agents also learn faster (so costs diverge through learning effects) or whether it is the less effcient agents who learn faster (so costs converge). We further show that an overexploitation of learning effects can occur also if the full-commitment assumption is relaxed.

The optimal disclosure policy when firms offer implicit contracts

Abstract: The observability of history is crucial for the sustenance of implicit (or relational) contracts. When a firm hires a sequence of short-lived workers, turnover adversely affects the observability of history—the old worker may leave the firm before communicating the history to the young. However,turnovercanalsoenhanceprofitsifmatchinggainscanbeextractedupfront.Disclosure of the workers’ productivity information affects turnover by mitigating adverse selection. Thus, the optimal disclosure policy trades off matching efficiency with the sustainability of implicit contracts. I show that (i) opaqueness can be optimal only for firms with moderate reputation concerns, and (ii) an opaque firm’s profit may decrease with its reputation concern.

Contracting with private knowledge of signal quality

Abstract: We characterize the optimal procurement contract in a setting where a supplier has privileged knowledge of the quality of a public signal about his production costs. The optimal contract exhibits important differences with standard contracts in adverse selection settings. For instance, the contract induces output both above and below first-best levels. Furthermore, the induced output may not vary with the realized public signal unless the signal quality is sufficiently pronounced. In addition, output may increase as expected costs increase.