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Monopoly Power and the Firm€ٳ Valuation:

  • Basak, Suleyman
  • Pavlova, Anna

Recent anti-trust cases exacerbated the concerns of investors regarding the effects of a firm's monopoly power on its production choice, shareholder value, and the overall economy. We address this issue within a dynamic equilibrium model featuring a large monopolistic firm whose actions not only affect the price of its output, but also effectively influence the valuation of its stock. The latter renders time inconsistency to the firm's dynamic production choice. When the firm is required to pre-commit to its strategy, the ensuing equilibrium is largely in line with the predictions of the textbook monopoly model. When the firm behaves in a time-consistent manner, however, the predictions are strikingly at odds. The trade-off between current profits and the valuation of future profits induces the firm to increase production beyond the competitive benchmark and cut prices. This policy may result in destroying shareholder value, and does indeed fully wipe out the firm's profit in the limit of the decision-making interval shrinking to zero, in line with the Coase conjecture.

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File URL: http://hdl.handle.net/1721.1/5421
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Paper provided by Massachusetts Institute of Technology (MIT), Sloan School of Management in its series Working papers with number 4234-01.

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Date of creation: 09 Jul 2004
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Handle: RePEc:mit:sloanp:5421
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Web page: http://mitsloan.mit.edu/

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  1. Basak, Suleyman & Pavlova, Anna, 2002. "Monopoly Power and the Firm's Valuation: A Dynamic Analysis of Short versus Long-Term Policies," CEPR Discussion Papers 3425, C.E.P.R. Discussion Papers.
  2. Sundaresan, S.M., 2000. "Continuous-Time Methods in Finance: A Review and an Assessment," Papers 00-03, Columbia - Graduate School of Business.
  3. Gene M. Grossman (ed.), 1992. "Imperfect Competition and International Trade," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262570939, June.
  4. Suleyman Basak, 1997. "Consumption choice and asset pricing with a non-price-taking agent," Economic Theory, Springer, vol. 10(3), pages 437-462.
  5. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-84, March.
  6. Jaskold Gabszewicz, Jean & Vial, Jean-Philippe, 1972. "Oligopoly "A la cournot" in a general equilibrium analysis," Journal of Economic Theory, Elsevier, vol. 4(3), pages 381-400, June.
  7. Birgit Grodal & Egbert Dierker, 1999. "The price normalization problem in imperfect competition and the objective of the firm," Economic Theory, Springer, vol. 14(2), pages 257-284.
  8. Pavlova, Anna & Rigobon, Roberto, 2003. "Asset Prices and Exchange Rates," Working papers 4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  9. Charles L. Schultze, 2003. "The Consumer Price Index: Conceptual Issues and Practical Suggestions," Journal of Economic Perspectives, American Economic Association, vol. 17(1), pages 3-22, Winter.
  10. Coase, Ronald H, 1972. "Durability and Monopoly," Journal of Law and Economics, University of Chicago Press, vol. 15(1), pages 143-49, April.
  11. Palley, Thomas I., 1997. "Managerial turnover and the theory of short-termism," Journal of Economic Behavior & Organization, Elsevier, vol. 32(4), pages 547-557, April.
  12. Larry M. Ausubel & Raymond J. Deneckere, 1989. "Reputation in Bargaining and Durable Goods Monopoly," Levine's Working Paper Archive 201, David K. Levine.
  13. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  14. Grinblatt, Mark S & Ross, Stephen A, 1985. "Market Power in a Securities Market with Endogenous Information," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1143-67, November.
  15. Suresh M. Sundaresan, 2000. "Continuous-Time Methods in Finance: A Review and an Assessment," Journal of Finance, American Finance Association, vol. 55(4), pages 1569-1622, 08.
  16. Ausubel, Lawrence M & Deneckere, Raymond J, 1989. "Reputation in Bargaining and Durable Goods Monopoly," Econometrica, Econometric Society, vol. 57(3), pages 511-31, May.
  17. Bonanno, Giacomo, 1990. " General Equilibrium Theory with Imperfect Competition," Journal of Economic Surveys, Wiley Blackwell, vol. 4(4), pages 297-328.
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