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Closure Options in Duopoly: The Case of Second-Mover Advantages

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Thomas Sparla
Abstract

This paper examines exercise policies for capacity reduction options in a duopolistic market that is subject to aggregate shocks. Firms face an inverse demand that exhibits second-mover advantages rather than the complementary property of first-mover advantages commonly assumed in the literature on games of investment timing. We identify a joint-reduction scenario to be the unique equilibrium outcome of the disinvestment timing game with identical firms. With heterogeneous firms one out of three scenarios occurs. Depending on the degree of heterogeneity either firms disinvest jointly or the high-cost firm moves first or a multiplicity of equilibria arises. All optimal exercise policies turn out to be different from the closure rules suggested by the standard real options theory: Identical as well as heterogeneous firms in duopoly should disinvest earlier than price-taking firms but later than a monopolist. A discussion of welfare and policy issues suggests a restrictive approach to the assessment of mergers in declining industries.

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Paper provided by University of Dortmund, Department of Economics in its series Discussion Papers in Economics with number 01_06.

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Length: 70 pages
Date of creation: Dec 2000
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Handle: RePEc:mik:wpaper:01_06

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  1. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-57, June. [Downloadable!] (restricted)
  2. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-38, June. [Downloadable!] (restricted)
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  3. Fudenberg, Drew & Tirole, Jean, 1985. "Preemption and Rent Equilization in the Adoption of New Technology," Review of Economic Studies, Blackwell Publishing, vol. 52(3), pages 383-401, July. [Downloadable!] (restricted)
  4. Fudenberg, Drew & Tirole, Jean, 1986. "A Theory of Exit in Duopoly," Econometrica, Econometric Society, vol. 54(4), pages 943-60, July. [Downloadable!] (restricted)
  5. Hoppe, Heidrun C., 2000. "Second-mover advantages in the strategic adoption of new technology under uncertainty," International Journal of Industrial Organization, Elsevier, vol. 18(2), pages 315-338, February. [Downloadable!] (restricted)
  6. Fine, Charles H. & Li, Lode, 1989. "Equilibrium exit in stochastically declining industries," Games and Economic Behavior, Elsevier, vol. 1(1), pages 40-59, March. [Downloadable!] (restricted)
  7. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-85, December. [Downloadable!] (restricted)
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  8. Weeds, Helen, 2002. "Strategic Delay in a Real Options Model of R&D Competition," Review of Economic Studies, Blackwell Publishing, vol. 69(3), pages 729-47, July.
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  9. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November. [Downloadable!] (restricted)
  10. Leahy, John V, 1993. "Investment in Competitive Equilibrium: The Optimality of Myopic Behavior," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1105-33, November. [Downloadable!] (restricted)
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