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Sunk Costs and Risk-Based Barriers to Entry

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Author Info
Robert S. Pindyck

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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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Find related papers by JEL classification:
D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
L40 - Industrial Organization - - Antitrust Issues and Policies - - - General

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  1. Dennis W. Carlton, 2004. "Why Barriers to Entry Are Barriers to Understanding," American Economic Review, American Economic Association, vol. 94(2), pages 466-470, May. [Downloadable!]
    Other versions:
  2. Felipe L. Aguerrevere, 2003. "Equilibrium Investment Strategies and Output Price Behavior: A Real-Options Approach," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 16(4), pages 1239-1272. [Downloadable!] (restricted)
  3. Margaret C. Levenstein & Valerie Y. Suslow, 2006. "What Determines Cartel Success?," Journal of Economic Literature, American Economic Association, vol. 44(1), pages 43-95, March. [Downloadable!] (restricted)
  4. Steven R. Grenadier, 2002. "Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(3), pages 691-721.
  5. Luís M. B. Cabral & Thomas W. Ross, 2008. "Are Sunk Costs a Barrier to Entry?," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 17(1), pages 97-112, 03. [Downloadable!] (restricted)
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  6. Pindyck, Robert S, 1993. "A Note on Competitive Investment under Uncertainty," American Economic Review, American Economic Association, vol. 83(1), pages 273-77, March. [Downloadable!] (restricted)
  7. Schmalensee, Richard, 2004. "Sunk Costs and Antitrust Barriers to Entry," Working papers 4457-04, Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
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  8. Preston R. Fee & Hugo M. Mialon & Michael A. Williams, 2004. "What Is a Barrier to Entry?," American Economic Review, American Economic Association, vol. 94(2), pages 461-465, May. [Downloadable!]
  9. Farrell, Joseph & Shapiro, Carl, 1990. "Horizontal Mergers: An Equilibrium Analysis," American Economic Review, American Economic Association, vol. 80(1), pages 107-26, March. [Downloadable!] (restricted)
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  10. 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. [Downloadable!] (restricted)
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  11. Heitor Almeida & Thomas Philippon, 2007. "The Risk-Adjusted Cost of Financial Distress," Journal of Finance, American Finance Association, vol. 62(6), pages 2557-2586, December. [Downloadable!] (restricted)
  12. 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. [Downloadable!] (restricted)
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