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Monopoly Power and the Firm's Valuation: A Dynamic Analysis of Short versus Long-Term Policies

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  • Basak, Suleyman
  • Pavlova, Anna

Abstract

This article develops a multi-period production model to examine the optimal dynamic behaviour of a large monopolistic value-maximizing firm that manipulates its valuation as well as the price of its output. In the pre-commitment equilibrium the firm’s output and labour demand are decreased, while the price of consumption is increased, as compared with its competitive counterpart. Profits and the firm's value can, however, be either increased or decreased. In the time-consistent equilibrium the firm’s output and labour demand are increased, while the price of consumption is decreased. More strikingly, the profits in every period are decreased, and may even go negative, while the firm's value can be either lower or higher than in the competitive benchmark. In the continuous-time limit, while the pre-commitment equilibrium retains its basic discrete-time structure, the time-consistent equilibrium tends to the limit of zero profits and hence zero firm's value.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3425.

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Date of creation: Jun 2002
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Handle: RePEc:cpr:ceprdp:3425

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Keywords: asset pricing theory; general equilibrium; monopoly; short-sighted; time-consistency;

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References

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  1. Grinblatt, Mark S & Ross, Stephen A, 1985. "Market Power in a Securities Market with Endogenous Information," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1143-67, November.
  2. Jaskold Gabszewicz, Jean & Vial, Jean-Philippe, 1972. "Oligopoly "A la cournot" in a general equilibrium analysis," Journal of Economic Theory, Elsevier, vol. 4(3), pages 381-400, June.
  3. Stein, Jeremy C, 1989. "Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 655-69, November.
  4. Davidson, Malcolm & Gorton, Gary B, 1995. "Stock Market Efficiency and Economic Efficiency: Is There a Connection?," CEPR Discussion Papers 1261, C.E.P.R. Discussion Papers.
  5. Egbert Dierker & Birgit Grodal, 1998. "The Price Normalization Problem in Imperfect Competition and the objective of the Firm," CIE Discussion Papers 1998-08, University of Copenhagen. Department of Economics. Centre for Industrial Economics.
  6. Sundaresan, S.M., 2000. "Continuous-Time Methods in Finance: A Review and an Assessment," Papers 00-03, Columbia - Graduate School of Business.
  7. Suleyman Basak, 1997. "Consumption choice and asset pricing with a non-price-taking agent," Economic Theory, Springer, vol. 10(3), pages 437-462.
  8. Jarrow, Robert A., 1992. "Market Manipulation, Bubbles, Corners, and Short Squeezes," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(03), pages 311-336, September.
  9. Palley, Thomas I., 1997. "Managerial turnover and the theory of short-termism," Journal of Economic Behavior & Organization, Elsevier, vol. 32(4), pages 547-557, April.
  10. Bonanno, Giacomo, 1990. " General Equilibrium Theory with Imperfect Competition," Journal of Economic Surveys, Wiley Blackwell, vol. 4(4), pages 297-328.
  11. Coase, Ronald H, 1972. "Durability and Monopoly," Journal of Law and Economics, University of Chicago Press, vol. 15(1), pages 143-49, April.
  12. Gene M. Grossman (ed.), 1992. "Imperfect Competition and International Trade," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262570939, December.
  13. Suresh M. Sundaresan, 2000. "Continuous-Time Methods in Finance: A Review and an Assessment," Journal of Finance, American Finance Association, vol. 55(4), pages 1569-1622, 08.
  14. Seppi, Duane J, 1992. "Block Trading and Information Revelation around Quarterly Earnings Announcements," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 281-305.
  15. Biais, Bruno & Hillion, Pierre, 1994. "Insider and Liquidity Trading in Stock and Options Markets," Review of Financial Studies, Society for Financial Studies, vol. 7(4), pages 743-80.
  16. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
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Cited by:
  1. Matthew Pritsker, 2005. "Large investors: implications for equilibrium asset, returns, shock absorption, and liquidity," Finance and Economics Discussion Series 2005-36, Board of Governors of the Federal Reserve System (U.S.).
  2. Basak, Suleyman & Pavlova, Anna, 2004. "Monopoly Power and the Firm€ٳ Valuation:," Working papers 4234-01, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  3. Branko Urosevic, 2001. "Moral hazard and dynamics of insider ownership stakes," Economics Working Papers 787, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2004.

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