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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. Schmalensee, Richard, 2004. "Sunk Costs and Antitrust Barriers to Entry," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 4457-04, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  2. Luis M.B. Cabral & Thomas Ross, 2006. "Are Sunk Costs A Barrier To Entry?," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 06-09, New York University, Leonard N. Stern School of Business, Department of Economics.
  3. Heitor Almeida & Thomas Philippon, 2005. "The Risk-Adjusted Cost of Financial Distress," NBER Working Papers 11685, National Bureau of Economic Research, Inc.
  4. Steven R. Grenadier, 2002. "Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 15(3), pages 691-721.
  5. Felipe L. Aguerrevere, 2003. "Equilibrium Investment Strategies and Output Price Behavior: A Real-Options Approach," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 16(4), pages 1239-1272.
  6. Farrell, J. & Shapiro, C., 1988. "Horizontal Mergers: An Equilibrium Analysis," Papers, Princeton, Woodrow Wilson School - Discussion Paper 17, Princeton, Woodrow Wilson School - Discussion Paper.
  7. Pindyck, Robert S, 1993. "A Note on Competitive Investment under Uncertainty," American Economic Review, American Economic Association, American Economic Association, vol. 83(1), pages 273-77, March.
  8. Preston R. Fee & Hugo M. Mialon & Michael A. Williams, 2004. "What Is a Barrier to Entry?," American Economic Review, American Economic Association, American Economic Association, vol. 94(2), pages 461-465, May.
  9. 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, American Finance Association, vol. 61(1), pages 437-461, 02.
  10. Francesco Franco & Thomas Philippon, 2007. "Firms and Aggregate Dynamics," The Review of Economics and Statistics, MIT Press, vol. 89(4), pages 587-600, November.
  11. Pindyck, Robert S., 2005. "Sunk Costs and Real Options in Antitrust," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 18233, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  12. David M. Kreps & Jose A. Scheinkman, 1983. "Quantity Precommitment and Bertrand Competition Yield Cournot Outcomes," Bell Journal of Economics, The RAND Corporation, The RAND Corporation, vol. 14(2), pages 326-337, Autumn.
  13. Dennis W. Carlton, 2004. "Why Barriers to Entry Are Barriers to Understanding," American Economic Review, American Economic Association, American Economic Association, vol. 94(2), pages 466-470, May.
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Cited by:
  1. Theodore H. Moran, 2013. "Avoiding the "Resource Curse" in Mongolia," Policy Briefs, Peterson Institute for International Economics PB13-18, Peterson Institute for International Economics.

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