We examine an incumbent's trade-off between expanding her business, which increases her profits, and the information that such expansion signals to potential competitors, which attracts them to the market. Specifically, we consider a signaling game where the incumbent knows the actual realization of demand, whereas the entrant can only observe whether the incumbent decided to expand the size of her business in the past. In particular, we analyze the set of pooling and separating equilibria surviving the intuitive criterion in this signaling model. Our results can support the more predictable observation that only incumbents in good market conditions expand their businesses (separating equilibria), but also the less obvious and interesting pooling equilibria in which no firm expands her business and despite such non-expansion, entrants choosing to enter the market. This equilibrium result helps us provide an explanation for the high failure rates that new firms face when entering a market, as confirmed by multiple empirical studies. Revised Feb. 2009.
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Paper provided by School of Economic Sciences, Washington State University in its series Working Papers with number
2008-16.
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