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Sunk Costs and Risk-Based Barriers to Entry

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  • Robert S. Pindyck

Abstract

In merger analysis and other antitrust settings, risk is often cited as a potential barrier to entry. But there is little consensus as to the kinds of risk that matter - systematic versus non-systematic and industry-wide versus firm-specific - and the mechanisms through which they affect entry. I show how and to what extent different kinds of risk magnify the deterrent effect of exogenous sunk costs of entry, and thereby affect industry dynamics, concentration, and equilibrium market prices. To do this, I develop a measure of the "full," i.e., risk-adjusted, sunk cost of entry. I show that for reasonable parameter values, the full sunk cost is far larger than the direct measure of sunk cost typically used to analyze markets.

Suggested Citation

  • Robert S. Pindyck, 2009. "Sunk Costs and Risk-Based Barriers to Entry," NBER Working Papers 14755, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:14755
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    References listed on IDEAS

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    1. Farrell, Joseph & Shapiro, Carl, 1990. "Horizontal Mergers: An Equilibrium Analysis," American Economic Review, American Economic Association, vol. 80(1), pages 107-126, March.
    2. Nicola Cetorelli & Philip E. Strahan, 2006. "Finance as a Barrier to Entry: Bank Competition and Industry Structure in Local U.S. Markets," Journal of Finance, American Finance Association, vol. 61(1), pages 437-461, February.
    3. Pindyck, Robert S., 2005. "Sunk Costs and Real Options in Antitrust," Working papers 18233, Massachusetts Institute of Technology (MIT), Sloan School of Management.
    4. Heitor Almeida & Thomas Philippon, 2007. "The Risk-Adjusted Cost of Financial Distress," Journal of Finance, American Finance Association, vol. 62(6), pages 2557-2586, December.
    5. Steven R. Grenadier, 2002. "Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms," Review of Financial Studies, Society for Financial Studies, vol. 15(3), pages 691-721.
    6. Francesco Franco & Thomas Philippon, 2007. "Firms and Aggregate Dynamics," The Review of Economics and Statistics, MIT Press, vol. 89(4), pages 587-600, November.
    7. Rchard Schmalensee, 2004. "Sunk Costs and Antitrust Barriers to Entry," American Economic Review, American Economic Association, vol. 94(2), pages 471-475, May.
    8. Luís M. B. Cabral & Thomas W. Ross, 2008. "Are Sunk Costs a Barrier to Entry?," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 17(1), pages 97-112, March.
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    10. Margaret C. Levenstein & Valerie Y. Suslow, 2002. "What Determines Cartel Success?," UMASS Amherst Economics Working Papers 2002-01, University of Massachusetts Amherst, Department of Economics.
    11. Felipe L. Aguerrevere, 2003. "Equilibrium Investment Strategies and Output Price Behavior: A Real-Options Approach," Review of Financial Studies, Society for Financial Studies, vol. 16(4), pages 1239-1272.
    12. Pindyck, Robert S, 1993. "A Note on Competitive Investment under Uncertainty," American Economic Review, American Economic Association, vol. 83(1), pages 273-277, March.
    13. Preston R. Fee & Hugo M. Mialon & Michael A. Williams, 2004. "What Is a Barrier to Entry?," American Economic Review, American Economic Association, vol. 94(2), pages 461-465, May.
    14. David M. Kreps & Jose A. Scheinkman, 1983. "Quantity Precommitment and Bertrand Competition Yield Cournot Outcomes," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 326-337, Autumn.
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    Cited by:

    1. Theodore H. Moran, 2013. "Avoiding the "Resource Curse" in Mongolia," Policy Briefs PB13-18, Peterson Institute for International Economics.

    More about this item

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
    • L40 - Industrial Organization - - Antitrust Issues and Policies - - - General

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