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Excess Capacity as an Incentive Device

  • Kerschbamer, Rudolf
  • Tournas, Yanni
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    This paper studies the factors determining plant size and interplant output allocation within the boundaries of a multiplant firm under conditions of demand uncertainty. It shows that asymmetric information between headquarters and individual plants is one factor determining plant size and output allocation: since the existence of excess capacity creates ‘high powered’ incentives for individual plants, capacity levels in a second-best setting exceed the corresponding benchmark in a first-best world if capacity prices are low. The presence of ‘agency costs’ in the case of fully-utilized capacity reverses this result for high-capacity prices. Also, in a recession output is not necessarily assigned to the plant with the lowest production costs.

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    File URL: http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=1625
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    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1625.

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    Date of creation: May 1997
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    Handle: RePEc:cpr:ceprdp:1625
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