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Investment Timing and Vertical Relationships

Author

Listed:
  • Etienne Billette de Villemeur

    (emlyon business school)

  • Richard Ruble
  • Bruno Versaevel

Abstract

We show that the standard analysis of vertical relationships transposes directly to investment dynamics. Thus, when a firm undertaking a project requires an outside supplier (e.g., an equipment manufacturer) to provide it with a discrete input to serve a growing but uncertain demand, and if the supplier has market power, investment occurs too late from an industry standpoint. The distortion in firm decisions is characterized by a Lerner-type index. Despite the underlying investment option, greater volatility can result in a lower value for both firms. We examine several contractual alternatives to induce efficient timing, a novel vertical restraint being for the upstream to sell a call option on the input. We also extend the model to allow for downstream duopoly. When downstream firms are engaged in a preemption race, the upstream firm sells the input to the first investor at a discount such that the race to preempt exactly offsets the vertical distortion, and this leader invests at the optimal time. These results are illustrated with a case study drawn from the pharmaceutical industry.

Suggested Citation

  • Etienne Billette de Villemeur & Richard Ruble & Bruno Versaevel, 2014. "Investment Timing and Vertical Relationships," Post-Print hal-02313058, HAL.
  • Handle: RePEc:hal:journl:hal-02313058
    Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-02313058
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    References listed on IDEAS

    as
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    Citations

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    Cited by:

    1. Pennings, Enrico, 2017. "Real options with ex-post division of the surplus," Journal of Banking & Finance, Elsevier, vol. 81(C), pages 200-206.
    2. Di Corato, Luca & Moretto, Michele & Rossini, Gianpaolo, 2017. "Financing flexibility: The case of outsourcing," Journal of Economic Dynamics and Control, Elsevier, vol. 76(C), pages 35-65.
    3. Billette de Villemeur, Etienne & Ruble, Richard & Versaevel, Bruno, 2019. "Dynamic competition and intellectual property rights in a model of product development," Journal of Economic Dynamics and Control, Elsevier, vol. 100(C), pages 270-296.
    4. Billette de Villemeur, Etienne & Ruble, Richard & Versaevel, Bruno, 2015. "On the timing of innovation and imitation," MPRA Paper 69161, University Library of Munich, Germany.
    5. Billette de Villemeur, Etienne & Ruble, Richard & Versaevel, Bruno, 2014. "Innovation and imitation incentives in dynamic duopoly," MPRA Paper 59453, University Library of Munich, Germany.
    6. Billette de Villemeur, Etienne & Ruble, Richard & Versaevel, Bruno, 2016. "When should a winner take all, or pay some? Innovation and imitation incentives in a dynamic duopoly," MPRA Paper 75465, University Library of Munich, Germany.
    7. M. Moretto & G. Rossini, 2015. "Vertical flexibility, outsourcing and the financial choices of the firm," Working Papers wp1009, Dipartimento Scienze Economiche, Universita' di Bologna.
    8. Dimitrios Zormpas, 2017. "How vertical relationships and external funding affect investment efficiency and timing?," 2017 Papers pzo81, Job Market Papers.
    9. Hellmann, Tobias & Thijssen, Jacco J.J., 2016. "Fear of the market or fear of the competitor? Ambiguity in a real options game," Center for Mathematical Economics Working Papers 533, Center for Mathematical Economics, Bielefeld University.
    10. Zormpas, Dimitrios, 2020. "Investments under vertical relations and agency conflicts: A real options approach," International Review of Economics & Finance, Elsevier, vol. 70(C), pages 273-287.
    11. Dimitrios Zormpas, 2021. "Jointly Held Investment Options and Vertical Relationships," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 58(4), pages 513-530, June.

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    More about this item

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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