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Sunk Costs and Risk-Based Barriers to Entry

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  • Robert S. Pindyck

Abstract

In merger analysis and other antitrust settings, risk is often cited as a potential barrier to entry. But there is little consensus as to the kinds of risk that matter - systematic versus non-systematic and industry-wide versus firm-specific - and the mechanisms through which they affect entry. I show how and to what extent different kinds of risk magnify the deterrent effect of exogenous sunk costs of entry, and thereby affect industry dynamics, concentration, and equilibrium market prices. To do this, I develop a measure of the "full," i.e., risk-adjusted, sunk cost of entry. I show that for reasonable parameter values, the full sunk cost is far larger than the direct measure of sunk cost typically used to analyze markets.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14755.

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Date of creation: Feb 2009
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Handle: RePEc:nbr:nberwo:14755

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  1. Felipe L. Aguerrevere, 2003. "Equilibrium Investment Strategies and Output Price Behavior: A Real-Options Approach," Review of Financial Studies, Society for Financial Studies, vol. 16(4), pages 1239-1272.
  2. Dennis W. Carlton, 2004. "Why Barriers to Entry are Barriers to Understanding," NBER Working Papers 10577, National Bureau of Economic Research, Inc.
  3. Thomas Philippon & Francesco Franco, 2005. "Firms and Aggregate Dynamics," 2005 Meeting Papers 246, Society for Economic Dynamics.
  4. Farrell, Joseph & Shapiro, Carl, 1988. "Horizontal Mergers: An Equilibrium Analysis," Department of Economics, Working Paper Series qt0tp305nx, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  5. Cabral, Luís M B & Ross, Thomas, 2007. "Are Sunk Costs a Barrier to Entry?," CEPR Discussion Papers 6162, C.E.P.R. Discussion Papers.
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  7. Schmalensee, Richard, 2004. "Sunk Costs and Antitrust Barriers to Entry," Working papers 4457-04, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  8. Nicola Cetorelli & Philip E. Strahan, 2006. "Finance as a Barrier to Entry: Bank Competition and Industry Structure in Local U.S. Markets," Journal of Finance, American Finance Association, vol. 61(1), pages 437-461, 02.
  9. Pindyck, Robert S., 2005. "Sunk Costs and Real Options In Antitrust," Working paper 237, Regulation2point0.
  10. Steven R. Grenadier, 2002. "Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms," Review of Financial Studies, Society for Financial Studies, vol. 15(3), pages 691-721.
  11. David M. Kreps & Jose A. Scheinkman, 1983. "Quantity Precommitment and Bertrand Competition Yield Cournot Outcomes," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 326-337, Autumn.
  12. Heitor Almeida & Thomas Philippon, 2005. "The Risk-Adjusted Cost of Financial Distress," NBER Working Papers 11685, National Bureau of Economic Research, Inc.
  13. Pindyck, Robert S, 1993. "A Note on Competitive Investment under Uncertainty," American Economic Review, American Economic Association, vol. 83(1), pages 273-77, March.
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Cited by:
  1. Theodore H. Moran, 2013. "Avoiding the "Resource Curse" in Mongolia," Policy Briefs PB13-18, Peterson Institute for International Economics.

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