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Excess Capacity as an Incentive Device

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  • Kerschbamer, Rudolf
  • Tournas, Yanni

Abstract

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.

Suggested Citation

  • Kerschbamer, Rudolf & Tournas, Yanni, 1997. "Excess Capacity as an Incentive Device," CEPR Discussion Papers 1625, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:1625
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    Keywords

    Asymmetric Information; Excess Capacity; Multiplant Firm;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • L23 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Organization of Production

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