Timing Vertical Relationships
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, 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 index, which is related to the parameters of a stochastic downstream demand. When feasible, vertical restraints restore efficiency. For instance, the upstream firm can induce entry at the correct investment threshold by selling a call option on the input. Otherwise, competition may substitute for vertical restraints. In particular, if two firms are engaged in a preemption race downstream, the upstream firm sells the input to the first investor at a discount that is chosen in such a way that the race to preempt exactly offsets the vertical externality, and this leader invests at the optimal market threshold.
|Date of creation:||23 Jun 2010|
|Date of revision:|
|Contact details of provider:|| Phone: (+33) 5 61 12 86 23|
Web page: http://www.tse-fr.eu/
More information through EDIRC
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.:
- Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474, 06-2016.
- 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.
- Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, March.
- 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.
When requesting a correction, please mention this item's handle: RePEc:tse:wpaper:22908. 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: ()
If references are entirely missing, you can add them using this form.