On the timing of vertical relationships
In a real option model, we show that the standard analysis of vertical relationships transposes directly to investment timing. 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 incertain 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, and we show how market growth rate and volatility affect the extent of the distortion. If the initial market demand is high, greater volatility increases the effective investment cost and results in lower value for both firms. Vertical restraints can restore efficiency. For instance, the upstream firm can induce entry at the correct investment threshold by selling a call option on the input. Otherwise, if two downstream firms are engaged in a preemption race, the upstream firm sells the input to the first investor at a discount which is chosen in such a way that the race to preempt exactly offsets the vertical distortion, and this leader invests at the optimal time.
|Date of creation:||2011|
|Date of revision:|
|Publication status:||Published in Working paper GATE 2011-18. 2011|
|Note:||View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-00585557|
|Contact details of provider:|| Web page: https://hal.archives-ouvertes.fr/|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Grenadier, Steven R, 1996. " The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets," Journal of Finance, American Finance Association, vol. 51(5), pages 1653-79, December.
- Thijssen, Jacco J.J. & Huisman, Kuno J.M. & Kort, Peter M., 2012.
"Symmetric equilibrium strategies in game theoretic real option models,"
Journal of Mathematical Economics,
Elsevier, vol. 48(4), pages 219-225.
- Thijssen, J.J.J. & Huisman, K.J.M. & Kort, P.M., 2002. "Symmetric Equilibrium Strategies in Game Theoretical Real Option Models," Discussion Paper 2002-81, Tilburg University, Center for Economic Research.
- Huisman, K.J.M. & Kort, P.M., 2013.
"Strategic Capacity Investment Under uncertainty,"
2013-003, Tilburg University, Center for Economic Research.
- John V. Leahy, 1993. "Investment in Competitive Equilibrium: The Optimality of Myopic Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 108(4), pages 1105-1133.
- Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474, 01-2013.
- Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, December.
- Mason, Robin & Weeds, Helen, 2010. "Investment, uncertainty and pre-emption," International Journal of Industrial Organization, Elsevier, vol. 28(3), pages 278-287, May.
When requesting a correction, please mention this item's handle: RePEc:hal:journl:halshs-00585557. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (CCSD)
If references are entirely missing, you can add them using this form.