The role of firm characteristics in pharmaceutical product launches

I examine the determinants of new pharmaceutical launches since 1980 in G7 nations. Both market and firm characteristics, and their interaction, are important in explaining entry. New drugs are 1.5 times more likely to be launched in markets that share a border or a language of a drug company's country of headquarters. The effect of competition depends on the characteristics of both the potential entrant and incumbents: domestic entrants prefer to compete with domestic incumbents. Despite the potential for licensing and low transportation costs, the match between the innovating firm and market conditions remains an important determinant of entry.     

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

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.     

Threat of entry and the use of discretion in banks’ financial reporting

This paper studies managers’ use of accounting discretion to deter entry. Using state-level changes in branching regulation under the Interstate Banking and Branching Efficiency Act, I find geographically-constrained community banks increased their loan loss provisions to appear less profitable when faced with the threat of entry by competitors. Additional tests rule out alternative explanations that firm economics or regulators drove the increase. I complement my analyses with survey-based evidence. Findings from the survey confirm that banks prefer to locate in markets where incumbents have high profitability and low credit losses, and that banks use competitors’ financial statements to analyze competition.     

The Bright Side of Internal Capital Markets

We examine capital expenditure decisions of discount firms in response to Wal-Mart's entry into their markets. Before Wal-Mart's entry, focused incumbents and discount divisions of diversified incumbents are similar in size, geographic dispersion, and firm debt levels. However, discount divisions of diversified firms are significantly more productive. After Wal-Mart's entry, diversified firms are quicker to either "exit" the discount business or "stay and fight." Also, their capital expenditures are more sensitive to the productivity of their discount business. Internal capital markets function well, as transfers are away from the worsening discount divisions. It appears diversified firms make better investment decisions.     

Corporate risk management,product market competition,and disclosure

This paper studies the effects of hedge disclosure requirements on corporate risk management and product market competition. The analysis is based on a model of market entry and shows that to prevent entry incumbent firms engage in risk management when these activities remain unobserved by outsiders. In the resulting equilibrium, financial markets are well informed and entry is efficient. However, potential attempts for more transparency by additional disclosure requirements introduce a commitment device that provides incumbents with incentives to distort risk management activities thereby influencing entrant beliefs. In equilibrium, firms engage in significant risk-taking. This behavior limits entry and adversely affects the nature of competition in industries.     

Informational Barriers to Entry into Credit Markets*

Economic theory suggests that asymmetric information between incumbents and entrants can generate barriers to entry into credit markets. Incumbents have superior information about their own customers and the overall economic conditions of the local credit market. This implies that entrants are likely to experience higher loan default rates than the incumbents. We test these theoretical predictions using a unique database of 7,275 observations on 729 individual banks’ lending in 95 Italian local markets. We find that informational asymmetries play a significant role in explaining entrants’ loan default rates. The default rate is significantly higher for those banks that entered local markets without opening a branch, suggesting that having a branch on site may help to reduce the informational disadvantage. We also uncover a positive correlation between banks’ loan default rates in individual local markets and the number of banks lending in that market. We argue that these informational barriers can help to explain why entry into many local credit markets by domestic and foreign banks was slow, even after substantial deregulation. * The views expressed in this article are those of the authors and do not involve the responsibility of the Bank of Italy. The authors thank Franklin Allen, Dario Focarelli, Andrea Generale, Luigi Guiso, Francesca Lotti, Marco Pagano, Alberto Franco Pozzolo, Paola Sapienza, Alessandro Secchi, two anonymous referees and seminar participants at the Bank of Italy, the Federal Reserve of Chicago, the 2003 BIS Workshop on Applied Banking Research, the 2003 EARIE Conference, the First Banca d’Italia/CEPR Conference on Money, Banking and Finance, the 2004 FIRS Conference on Banking, Insurance and Intermediation and the 2004 EEA Meeting for their comments. The usual disclaimer applies to all of them.     

Whom You Know Matters: Venture Capital Networks and Investment Performance

Many financial markets are characterized by strong relationships and networks, rather than arm's‐length, spot market transactions. We examine the performance consequences of this organizational structure in the context of relationships established when VCs syndicate portfolio company investments. We find that better‐networked VC firms experience significantly better fund performance, as measured by the proportion of investments that are successfully exited through an IPO or a sale to another company. Similarly, the portfolio companies of better‐networked VCs are significantly more likely to survive to subsequent financing and eventual exit. We also provide initial evidence on the evolution of VC networks.     

CARE Conference Hong Kong Polytechnic University,June 9, 2014: Equity Financing for Early‐Stage Companies in China

Many of the smaller private‐sector Chinese companies in their entrepreneurial growth stage are now being funded by Chinese venture capital (VC) and private equity (PE) firms. In contrast to western VC markets, where institutional investors such as pension funds and endowments have been the main providers of capital, in China most capital for domestic funds has come from private business owners and high net worth individuals. As relatively new players in the market who are less accustomed to entrusting their capital to fund managers for a lengthy period of time, Chinese VCs and their investors have shown a shorter investment horizon and demanded a faster return of capital and profits. In an attempt to explain this behavior, Paul Gompers and Josh Lerner of Harvard Business School have offered a “grandstanding hypothesis” that focuses on the incentives of younger, less established VCs to push their portfolio companies out into the IPO market as early as they can—and thus possibly prematurely—to establish a track record and facilitate future fundraising. This explanation is supported by the under‐performance of Chinese VC‐backed IPOs that has been documented by the author's recent research. Although they continue to offer significant opportunities for global investors, China's VC and PE markets still face many challenges. The supervisory system and legal environment need further improvement, and Chinese funds need to find a way to attract more institutional investors—a goal that can and likely will be promoted through government inducements.     

Strategic responses of incumbents to new entry: the effect of ownership structure: capital structure, and focus

We examine how certain firm- and market-specific characteristicsaffect incumbent firms' responses to new entry into their localmarkets. Data comes from the discount department store industrywhere Wal-Mart entered a large number of markets in a shortperiod of time. Consistent with existing research, larger andmore profitable incumbents respond more aggressively to Wal-Mart'sentry, while more highly levered incumbents respond less aggressively.Also, there is evidence that incumbent managers fight harder(possibly overinvest) when their job is at greater risk andhigh managerial ownership appears to reduce this agency problem.Incumbent firms behave differently in markets under attack byWal-Mart than in markets not yet threatened, suggesting thatsome of the documented responses are specific to Wal-Mart'sentry.     

Competition among mutual funds

We examine the impact of the entry of new mutual funds on incumbents using the overlap in their portfolio holdings as a measure of competitive intensity. This simple metric delivers powerful economic results. Incumbents that have a high overlap with entrants subsequently engage in price competition by reducing management fees. Distribution fees, however, rise so that investors do not benefit as much from price competition. Funds with high overlap also experience quantity competition through lower investor flows, have lower alphas, and higher attrition rates. These effects only appear after the late 1990s, at which point there appears to be an endogenous structural shift in the competitive environment. We conclude that the mutual fund market has evolved into one that displays the hallmark features of a competitive market.     

The effect of entry on R&D networks

We investigate the effect of potential entry on the formation and stability of R&D networks considering farsighted firms. The presence of a potential entrant often alters the incentives of incumbents to collaborate. Incumbent firms may form an otherwise undesirable collaboration to deter entry of a new firm. Moreover, an incumbent may refrain from establishing an otherwise desirable collaboration, expecting to form a more profitable link with the entrant. Finally, potential entry may lead an inefficient incumbent to exit the market. Welfare analysis shows market and social incentives to be often misaligned. We propose a subsidy scheme that encourages welfare‐improving entry.     

Leverage and strategic preemption: Lessons from entry plans and incumbent investments

This paper empirically investigates the effect of leverage on strategic preemption. Using new data on entry plans and incumbent investments from the American casino industry, I find that high leverage prevents incumbents from responding to entry threats. Facing the same set of entry plans, low-leverage incumbents expand physical capacity (by 30%), whereas high-leverage incumbents do not. This difference in investment matters because capacity installations preempt eventual entry. Stock market reactions to withdrawn plans imply that effective preemption increases incumbent firm value by 5%. My findings suggest that leverage matters for industry composition, not just firm-level investment.     

All strategy is local

The aim of strategy is to master a market environment by understanding and anticipating the actions of other economic agents, especially competitors. A firm that has some sort of competitive advantage-privileged access to customers, for instance--will have relatively few competitors to contend with, since potential competitors without an advantage, if they have their wits about them, will stay away. Thus, competitive advantages are actually barriers to entry and vice versa. In markets that are exposed, by contrast, competition is intense. If the incumbents have even brief success in earning greater than normal returns on investments, new entrants will swarm in to grab a share of the profits. Sooner or later, the additional competition will push returns as far down as the firms' costs of capital. For firms operating in such markets, the only choice is to forget about strategy and run the business as efficiently as possible. Barriers to entry are easier to maintain in a competitive arena that is "local", either in the geographic sense or in the sense of being limited to one product or a handful of related ones. The two most powerful competitive advantages-customer captivity and economies of scale-are more achievable and sustainable in circumscribed markets of this kind. Their opposites are the open markets and host of rivals that are features of globalization. Compapies entering such markets risk frittering away the advantages they secured on smaller playing fields.., Ifa company wants to grow but still obtain superior returns, the authors argue, the best strategy is to dominate a series of discrete but preferably contiguous markets and then expand only at their edges. WalMart's diminishing margins over the past 15 years are strong evidence of the danger of proceeding otherwise.     

On the strategic use of debt and capacity in rapidly expanding markets

We exploit the 1996 telecommunications deregulation as a quasi-natural experiment to investigate whether incumbents alter debt and capacity tactics when facing new rivals. We find that incumbents increase leverage after deregulation, even when controlling for traditional determinants and market conditions. Consistent with a new post-deregulation benefit, a higher leverage is positively related to market shares. This behavior appears only in telecommunication segments most affected by the deregulation. We find weak evidence for increased use of capacity tactics. Our findings for incumbents facing an influx of rivals in a rapidly expanding market differ from those of earlier studies considering mature markets.     

Optimal product variety in radio markets

A vast theoretical literature explores inefficient market structures in free‐entry equilibria, and previous empirical work demonstrated that excessive entry may obtain in local radio markets. We extend that literature by relaxing the assumption that stations are symmetric, allowing for endogenous horizontal and (unobserved) vertical station differentiation. We find that, in most broadcasting formats, a social planner who takes into account the welfare of market participants eliminates 50%–60% of the observed stations. In 80%–94.9% of markets where high‐quality stations are observed, welfare could be unambiguously improved by converting one such station into low‐quality broadcasting, suggesting local overprovision of quality.     

The great industry gamble: market structure dynamics as a survival contest

Industry dynamics are studied as an endogenous tournament with infinite horizon and stochastic entry. In each period, firms’ investments determine their probability of surviving into the next period. This generates a survival contest, which fuels market structure dynamics, while the evolution of market structure constantly redefines the contest. More concentrated markets endogenously generate less profit, rivals that are more difficult to outlive, and more entry. The unique steady‐state distribution exhibits ongoing turbulence, correlated exit and entry rates, and shakeouts. The model’s predictions fit empirical findings in markets where firms trade off profits for smaller risk of failure (e.g., banking).     

Strategies to crack well-guarded markets

How can companies break into attractive markets, where incumbents erect many barriers to entry? To answer this question, the authors studied organizations that successfully entered the most profitable industries in the United States between 1990 and 2000. When they dissected the strategies that worked best, one common theme stood out: indirect assault. Smart newcomers don't duplicate existing business models, compete for crowded distribution channels, or go after mainstream customers right away. Instead, they attack the enemy at its weakest points; then gain competitive advantage; and later, if doing so meets their objectives, go after its strongholds. Recent battles in the soft drink industry--where brands, bottling and distribution capabilities, and shelf space are incumbents' main advantages--are a case in point. When Virgin Drinks entered the U.S. cola market in 1998, it advertised heavily and immediately tried to get into the retail outlets that stock the leading brands. Virgin has never garnered more than a 1% share of the market. Red Bull, by contrast, came on the scene in 1997 with a niche product: a carbonated energy drink. The company started by selling the drink at bars and nightclubs. After gaining a loyal following through these outlets, Red Bull elbowed its way into the corner store. In 2005 it enjoyed a 65% share of the $650 million energy drink market. Successful entrants use three basic approaches in their indirect attacks. They leverage their existing assets and resources, reconfigure their value chains, and create niches. These approaches may appear to be simple, but their magic lies in their combination. By mixing and matching them, Bryce and Dyer say, enterprises can defy half a century of economic logic and make money entering highly profitable industries. The authors use Skype, Costco, Skechers, and many other companies to illustrate their argument.     

Threat of entry and debt maturity: Evidence from airlines

I explore the effect of the threat posed by low-cost competitors on debt structure in the airline industry. I use the route network expansion of low-cost airlines to identify routes where the probability of future entry increases dramatically. I find that when a large portion of their market is threatened, incumbents significantly increase debt maturity before entry occurs. Overall, the main findings suggest that airlines respond to entry threats trading off the benefits of short-term financing for lower rollover risk. The results are consistent with models in which firms set their optimal debt structure in the presence of costly rollover failure.     

IPO withdrawals: Are corporate governance and VC characteristics the guiding light in the rough sea of volatile markets?

More than 25% of all US firms that file for an IPO withdraw their offering from registration. Our study, which includes 3438 US domestic first-time IPO filings between 1997 and 2014, examines whether in times of high market volatility, high-quality corporate governance and VC backing may serve as a signal and thus reduce the withdrawal probability. Our results from an interaction term analysis support the view that corporate governance characteristics, but not the VC backing per se, tend to provide signals in highly volatile markets. In addition, our paper delves into the effect of VC characteristics. Local VCs tend to reduce the withdrawal probability. The same holds for VC syndication, particularly in highly volatile markets. Finally, our findings lend support to the conclusion that in highly volatile environments, reputable VCs tend to follow the dual-track strategy or postpone the IPO of their portfolio firms more often than in less volatile markets.     

Entry Decisions and Adverse Selection: An Empirical Analysis of Local Credit Markets

During the last decades there has been a widespread relaxation of legal entry barriers into the banking industry, with potential benefits for financial integration and competition. Obstacles to banks geographical and business expansion have been removed and branching has been substantially liberalized. This paper analyses the determinants of entry decisions into local credit markets using a unique data set before and after deregulation of the Italian banking industry. We estimate an entry model à la Poisson and find evidence that spreads between loan and deposit rates drive entry only for newly chartered banks, but does not affect the decision to open branches of banks operating in other markets. Branching by outside banks is instead positively correlated with business opportunities in the provision of financial services which do not require the acquisition of substantial proprietary information. Both these results are consistent with the hypothesis that in credit markets incumbents have an informational advantage over new entrants.