Recent anti-trust cases exacerbated the concerns of investors regarding the effects of a firm's monopoly power on its production choice, shareholder value, and the overall economy. We address this issue within a dynamic equilibrium model featuring a large monopolistic firm whose actions not only affect the price of its output, but also effectively influence the valuation of its stock. The latter renders time inconsistency to the firm's dynamic production choice. When the firm is required to pre-commit to its strategy, the ensuing equilibrium is largely in line with the predictions of the textbook monopoly model. When the firm behaves in a time-consistent manner, however, the predictions are strikingly at odds. The trade-off between current profits and the valuation of future profits induces the firm to increase production beyond the competitive benchmark and cut prices. This policy may result in destroying shareholder value, and does indeed fully wipe out the firm's profit in the limit of the decision-making interval shrinking to zero, in line with the Coase conjecture.
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Paper provided by Massachusetts Institute of Technology (MIT), Sloan School of Management in its series Working papers with number
4234-01.
Length: Date of creation: 09 Jul 2004 Date of revision: Handle: RePEc:mit:sloanp:5421
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Pavlova, Anna & Rigobon, Roberto, 2003.
"Asset Prices and Exchange Rates,"
Working papers
4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
[Downloadable!]
Pavlova, Anna & Rigobon, Roberto, 2004.
"Asset Prices and Exchange Rates,"
Working papers
4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
[Downloadable!]