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Allocating cost reducing investments over competing divisions

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  • TESORIERE, Antonio

Abstract

This paper examines a three-stage model of divisionalization where, first, two parent firms create independent units, second, the parent firms allocate cost reduction levels over these units, and third, the resulting units compete in a Cournotmarket given their current costs of production. The introduction of the cost reduction phase is shown to reduce the incentives toward divisionalization severely, relative to other existing models. Namely, the scope for divisionalization in equilibrium reduces as the marginal cost of the cost reducing investment decreases, and eventually vanishes. A second-best welfare analysis shows that, for any given market structure, the equilibrium investment decisions of the parent firms are socially optimal. In addition, the no divisionalization outcome is sustainable in equilibrium only if it is socially optimal.

Suggested Citation

  • TESORIERE, Antonio, 2007. "Allocating cost reducing investments over competing divisions," CORE Discussion Papers 2007036, Universit√© catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  • Handle: RePEc:cor:louvco:2007036
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    File URL: http://www.uclouvain.be/cps/ucl/doc/core/documents/coredp2007_36.pdf
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    Keywords

    divisionalization; horizontal mergers; research joint ventures;

    JEL classification:

    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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