Cross-border mergers in vertically related industries

We construct a tractable model of an oligopolistic industry that allows us to capture the role of the vertical structure in the incentives for and implications of cross-border horizontal mergers. We show that vertical integration can increase the gains from cross-border mergers. We also demonstrate how market concentration interacts with costs in the decision of a relatively efficient foreign firm located in one country (source) to merge with a disintegrated or an integrated firm in another country (target) when the industry is vertically related. Absent any merger incentives in an autarkic equilibrium, we demonstrate that vertical integration can raise the incentives for diversification in production and add to the gains from cross-border horizontal mergers. Any additional gain from cross-border horizontal mergers, due to the existence of a vertically integrated production structure, is shown to be sensitive to the relative market concentration across countries. Cross-border mergers will be triggered by a relatively cost-efficient source taking over a disintegrated target when pre-merger competition among the disintegrated firms is relatively intense but, otherwise, the initial target will be a vertically integrated firm.     

Incentives for Discrimination when Upstream Monopolists Participate in Downstream Markets

A regulated upstream monopolist supplies an essential input to firms in a downstream market. If an upstream monopolist vertically integrates downstream, non-price discrimination becomes a concern. Discrimination always arises in equilibrium when the vertically integrated provider (VIP) is no less efficient than its rivals in the downstream market, but it does not always arise when the VIP is less efficient than its rivals. Numerical simulations that parameterize the regulator's ability to monitor discrimination in the case of long-distance telephone service in the U.S. reveal that pronounced efficiency differentials are required for the incentive to discriminate not to arise in equilibrium.     

Using Market Structure to Regulate a Vertically Integrated Monopolist

A natural monopolist whose cost is private information produces a good which is combined with another good that can be produced by the monopolist or by other firms. The agency that regulates the monopolist can impose any of several different market structures in the industry: integrated monopoly, vertical separation with free entry downstream, or liberalization downstream (both integrated and independent production). When several firms produce downstream, a Cournot quantity-setting game with free entry determines the market price. We derive the optimal contracts to offer the monopolist under all three market structures and examine the influence of downstream cost differences on access prices.We then study the optimal regulatory policy where the regulator can condition the downstream market structure on the monopolist's cost report to the regulator. The optimal regulatory policy awards a monopoly to a low-cost upstream firm, but requires free entry downstream if the monopolist reports high upstream costs. Thus, the choice of market structure is an additional tool to limit rent extraction by the monopolist. Simulation analysis reveals the possibility of significant welfare gains from this additional regulatory tool.     

Incentives to invest and to give access to non-regulated new technologies

We analyze the incentives of a vertically integrated firm, which is a regulated monopolist in the wholesale market and competes with an entrant in the retail market, to invest and to give access to a new wholesale technology. The new technology represents a non-drastic innovation that produces retail services of a higher quality than the old technology, and is left unregulated. We show that for intermediate values of the access price for the old technology, the vertically integrated firm may decide not to invest. When investment occurs, the vertically integrated firm may be induced to give access to the entrant for a low access price for the old technology. Furthermore, when both firms can invest, investment occurs under a larger set of circumstances, and it is the entrant the firm that invests in more cases. We also discuss the implications for the regulation of the old technology.     

Entry in a Dynamic Model with Equilibrium Price Dispersion with an Application to the Market for Long-Distance Telephone Services

Models of entry based on the traditional models of oligopoly do not allow for price dispersions on homogenous products. Yet, such price dispersions do exist for homogenous products, and a firm does not lose its entire market share when it fails to charge the lowest price. Existing models of equilibrium price dispersion are not designed to analyze entry in a dynamic framework. A dynamic model is developed that allows an analysis of the effects of entry into a previously monopolized market. Despite asymmetric initial shares, the market shares of equally efficient firms tend to equalize over time. An application is the market for long‐distance telephone services following the divestiture of the bell operating companies from AT&T.     

INTERNATIONAL WELFARE AND EMPLOYMENT LINKAGES ARISING FROM MINIMUM WAGES*

We formulate a two‐country model with monopolistic competition and heterogeneous firms to reconsider labor market linkages in open economies. Labor market imperfections arise by virtue of country‐specific real minimum wages. Abstracting from selection of just the best firms into export status, standard effects on marginal and average firm productivity are reversed in our model, yet there are significant gains from trade arising from employment expansion. In addition, we show that with firm heterogeneity an increase in one country’s minimum wage triggers firm exit in both countries and thus harms workers at home and abroad.     

R&D subsidies in a duopoly market with outsourcing to the rival firm

This paper investigates the effects of a public uniform R&D subsidy policy in a downstream duopoly market in which a nonintegrated firm, which faces a lower marginal cost, outsources inputs from its vertically integrated rival. The findings show that, in this market structure, such a policy has relevant effects largely differentiated between downstream competitors, as it can significantly modify the relative market shares and profitability of competing firms. Unlike the standard Cournot setting augmented with R&D, results show that the subsidy policy can have different (counterintuitive) effects on R&D investments, output, and profits of the vertically integrated producer and the vertically separated firm, which hold in both cases of exogenous and endogenous (optimal) subsidy. Our findings offer some testable implications and suggest that a subsidy policy in a market with outsourcing to a rival should also consider the different effects of this approach on competitors.     

Structural Estimation of Variety Gains from Trade Integration in Asia

This article studies the variety gains of trade integration in Asia. Adopting a heterogeneous firm model of trade of monopolistic competition allowed us to estimate not only the welfare gains because of country specialisation, but also the variety gains arising from trade integration. The underlying structural parameters were estimated econometrically, based on a large panel of firm‐level data for the Asian economies (ORIANA). Our empirical findings suggest that, when relaxing the assumption of firm homogeneity and accounting for export market entry costs, the gains from trade integration are higher than in conventional models with representative firms.     

Indirect versus Direct Constraints in Markets with Vertical Integration

For an assessment of market power on the wholesale (or merchant) market in the presence of vertically integrated firms, we analyze the interaction of direct constraints, arising from competition on the wholesale market, and of indirect constraints, arising from substitution on the retail market. A vertically integrated firm that still participates in the merchant market exerts both direct and indirect constraints. We analyze the factors that determine the importance of indirect constraints. We find that, in contrast to a common presumption, indirect constraints are sometimes more powerful than direct constraints. We furthermore analyze the incentives of integrated firms to still participate in the merchant market, provided that this is technologically feasible.     

Renewable Energy Policy Instruments and Market Power

Markets for green certificates allow generators with market power to squeeze the margins of their competitors, as a generator that is vertically integrated into network activities might do. We analyze this issue in a stylized electricity industry in which a dominant producer of both conventional and renewable energy is facing a competitive fringe of renewable‐energy producers. We demonstrate that whether or not a dominant firm is vertically integrated into network activities, it can disadvantage the fringe producers by distorting certificates prices, thereby inducing cost inefficiency in the generation of renewable energy. We compare green certificates to a system of feed‐in tariffs, where a similar margin squeeze is not possible.     

Sequential Entry in a Vertically Differentiated Market

This paper considers a sequential entry game of homogeneous firms in a vertically differentiated market. A firm can choose any variety of products, with a fixed cost per product. Each product can be withdrawn afterwards without exit costs. Then each firm chooses one product at most in equilibrium because of a commitment problem. The first firm chooses the highest quality if the fixed cost is so large that subsequent entry is blockaded. It chooses middle quality to deter entry of a low–quality firm if the fixed cost decreases. Hence everyone becomes worse off as the entrant becomes more dangerous. JEL Classification Numbers: D43, L13.     

Strategic spin-offs of input divisions

When a downstream producer enters backward into the input market, a “helping the rivals effect” exists: Such entry hurts the firm's downstream business as it increases upstream competition and thus benefits its rival downstream firms. This negative externality prevents the newly-created upstream unit from expanding. A spin-off enables the firm to credibly expand in the input market, thereby forcing its upstream competitors to behave less aggressively. Spin-offs occur in equilibrium if and only if the number of downstream firms exceeds a threshold level. When there is more than one integrated firm, a spin-off by a firm can trigger spin-offs by others that would not occur otherwise.     

Entry and exit as a source of aggregate productivity growth in two alternative technological regimes

This paper proposes a neo-Schumpeterian model in order to discuss how the mechanisms of entry and exit contribute to industry productivity growth in alternative technological regimes. Our central hypothesis is that new firms generate gains in aggregate productivity by increasing both the productivity level and competition intensity. By assuming that firms learn about the relevant technology through a variety of sources, and by allowing a continuous flow of entry and exit into the market, our study shows that firm exit and output contraction take mostly place among less productive firms, while output expansion and entry are concentrated among the more efficient ones. The greater is the competitive pressure generated by new entrants, the higher is the expected productivity level of established firms. Overall, our analysis suggests that micro analysis is the proper complement to aggregate industry studies, as it provides a considerable insight into the causes of productivity growth.     

The impact of product market regulation on productivity through firm churning: Evidence from European countries

Productivity performance in European countries has been a policy concern for several decades. This paper shows that productivity can be enhanced by product market policies which, by increasing competition and efficiency, facilitate higher rates of firms’ entry and exit (i.e. firm churning). Drawing on annual country-sector data for the period 2000–2014 across the EU countries, we find that: (i) competition-enhancing regulation is associated with a higher rate of firm churning; (ii) firm churning, in turn, appears to be positively related to higher total factor productivity at the sector level by facilitating the entry of new competitive firms and the exit of less productive ones. Overall, we conclude that stringent product market regulation can be indirectly associated, via its impact on business dynamism, with the somewhat weak productivity performance in a number of EU countries. Thus, our results point towards substantial productivity gains that could follow from the introduction of further competition-enhancing measures in product markets.     

Entry decision of a vertically integrated foreign firm with downstream subsidization and upstream privatization

This study considers a vertical structure model in which an upstream state-owned enterprise (SOE) and a downstream domestic firm compete with a vertically integrated foreign firm (VIFF). We consider the cost-inefficiency of the SOE and examine the entry decisions of a VIFF under downstream subsidization. We find that without upstream privatization, the VIFF's entry decision might not be socially desirable unless it enters both markets and the cost inefficiency is intermediate. Additionally, a policy to reduce the cost inefficiency might cause a drastic welfare increase or loss when the VIFF changes its entry decision. We then examine upstream privatization and show that a substantial improvement in cost efficiency can increase welfare with privatization. When the SOE maximizes welfare, however, lesser (greater) cost efficiency improvement is necessary to increase welfare with privatization if the ex-ante cost inefficiency is high (low).     

Incentives for input foreclosure

We analyze the incentives of a vertically integrated firm to foreclose downstream rivals in a model of upstream price competition between suppliers of only imperfectly substitutable inputs. Our main motivation is a critical assessment of common assertions that draw inferences from pre-merger observable variables to post-merger incentives to foreclose. In particular, we find that, contrary to some commonly expressed views, high margins on the downstream and low margins on the upstream market are not good predictors for the incentives of a newly integrated firm to foreclose rivals. Besides this contribution to policy, our model also extends existing results in the literature on vertical foreclosure through allowing for the interaction of product differentiation on the upstream and on the downstream market.     

LIBERALIZATION WITHOUT DEREGULATION: U.S. TELECOMMUNICATIONS POLICY DURING THE 1980s

During the past 20 years, the U.S. telephone industry has undergone a remarkable evolution from a set of government-enforced monopolies to a much more competitive environment. Long-distance service, private-line service, data communications, and terminal equipment once were available only from the telephone monopolist. Now they are freely available from numerous competitive suppliers due to a series of regulatory and judicial decisions. But despite this veritable explosion in competition, the telephone industry still is regulated at both the federal and state levels. Only the provision of terminal equipment is totally deregulated.
Regulating telephone rates has created a highly inefficient rate structure replete with cross-subsidies. Legislators' and state regulators' reluctance to eliminate these cross-subsidies remains the most important hurdle to transforming the telephone industry to a fully competitive market. Nevertheless, liberalizing entry has generated some economic efficiencies through its effect on productive efficiency and on regulated rates. Productive efficiency gains may have reached $3 billion by 1988, and the welfare gains from the limited rationalization of rates caused by entry are nearly $1 billion per year.
Fully deregulating long-distance and local service requires that regulators abandon their policies of cross-subsidizing rural residences at the expense of businesses and of cross-subsidizing local service at the expense of long-distance service. Movement toward deregulation is progressing at the federal level and in some states, but full deregulation appears unlikely in the foreseeable future.     

Strategic R&D policy under vertically differentiated oligopoly

In this paper strategic R&D policy is analysed, where a high-tech firm and a low-tech firm compete in a third country with vertically differentiated ( high-quality and low-quality ) products. If the product market is under price competition, the high-tech (low-tech) firm's government has an incentive to tax (subsidize) its domestic firm's product R&D activities. If the product market is under quantity competition, the results are opposite: an R&D subsidy (tax) incentive for the high-tech (low-tech) firm's government; and the high-tech firm's government always gains in the R&D policy game, in contrast to the standard prisoner's dilemma result of the R&D policy literature. JEL Classification: F13     

STRATEGIC OUTSOURCING UNDER ECONOMIES OF SCALE

We show that economies of scale in upstream production can lead both the disintegrated downstream firm as well as its vertically integrated rival to outsource offshore for intermediate goods, even if offshore production has a moderate cost disadvantage compared to in‐house production of the vertically integrated firm.     

Strategic delay in market entry

Abstract.  Two firms are contemplating entry into a market that is viable for only one firm in a good state. We show that even if each firm receives a signal that perfectly reveals a good state, both might strategically delay entry, owing to the fear that the other firm might enter in the same period as well. We also find the conditions where the informed firm will let the rival firm know about the market's profitability and the two will merge to enter the market. We discuss the applications of this model to the oil industry and the generic drug industry.