An empirical investigation of the stepping-stone hypothesis

To increase competition in local telephone markets, the 1996 Telecommunications Act required incumbent firms to lease important inputs to competitors at regulated prices. Defending this so-called stepping-stone hypothesis, the Federal Communications Commission argued that new entrants needed a foothold in the market- gained by leasing inputs- before they could build their own facilities. Conversely, critics denied the stepping-stone hypothesis by arguing that easier access to inputs discourages new firms from building facilities. Using a new state-level dataset, we empirically test the stepping-stone hypothesis by exploring the effect of regulated input prices on facilities-based entry. Contradicting key results of existing research, we find that under certain conditions, lower regulated input prices can increase facilities-based entry. These findings partially validate the stepping-stone hypothesis.