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Sunk costs, market contestability, and the size distribution of firms

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  • Kessides, Ioannis N.
  • Tang, Li

Abstract

This paper offers a new economic explanation for the observed inter-industry differences in the size distribution of firms. The empirical estimates--based on three temporal (1982, 1987, and 1992) cross-sections of the four-digit United States manufacturing industries--indicate that increased market contestability, as signified by low sunk costs, tends to reduce the dispersion of firm sizes. These findings provide support for one of the key predictions of the theory of contestable markets: that market forces under contestability would tend to render any inefficient organization of the industry unsustainable and, consequently, tighten the distribution of firms around the optimum.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 5540.

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Date of creation: 01 Jan 2011
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Handle: RePEc:wbk:wbrwps:5540
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Keywords: Markets and Market Access; Economic Theory&Research; Water and Industry; Access to Markets; Debt Markets;

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Find related papers by JEL classification:
  • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
  • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
  • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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  1. Vivek Ghosal, 2003. "Impact of Uncertainty and Sunk Costs on Firm Survival and Industry Dynamics," CIG Working Papers SP II 2003-12, Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG).
  2. Kwoka, John E, Jr & White, Lawrence J, 2001. "The New Industrial Organization and Small Business," Small Business Economics, Springer, vol. 16(1), pages 21-30, February.
  3. Luís Cabral & Thomas Ross, 2007. "Are Sunk Costs a Barrier to Entry?," Working Papers 19, Portuguese Competition Authority.
  4. Jong-Rong Chen & Wen-Cheng Lu, 2003. "Panel unit root tests of firm size and its growth," Applied Economics Letters, Taylor & Francis Journals, vol. 10(6), pages 343-345.
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  7. Baumol, William J, 1982. "Contestable Markets: An Uprising in the Theory of Industry Structure," American Economic Review, American Economic Association, vol. 72(1), pages 1-15, March.
  8. Berry, Steven & Reiss, Peter, 2007. "Empirical Models of Entry and Market Structure," Handbook of Industrial Organization, Elsevier.
  9. Blandina Oliveira & Adelino Fortunato, 2006. "Testing Gibrat's Law: Empirical Evidence from a Panel of Portuguese Manufacturing Firms," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 13(1), pages 65-81.
  10. Francesca Lotti & Enrico Santarelli & Marco Vivarelli, 2009. "Defending Gibrat’s Law as a long-run regularity," Small Business Economics, Springer, vol. 32(1), pages 31-44, January.
  11. Schmalensee, Richard, 1989. "Inter-industry studies of structure and performance," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 16, pages 951-1009 Elsevier.
  12. Ghosal, Vivek, 2007. "Small is Beautiful but Size Matters: The Asymmetric Impact of Uncertainty and Sunk Costs on Small and Large Businesses," MPRA Paper 5461, University Library of Munich, Germany.
  13. White, Lawrence J, 1982. "The Determinants of the Relative Importance of Small Business," The Review of Economics and Statistics, MIT Press, vol. 64(1), pages 42-49, February.
  14. Geroski, Paul A & Samiei, Hossein & Urga, Giovanni, 1997. "Are Differences in Firm Size Transitory or Permanent?," CEPR Discussion Papers 1691, C.E.P.R. Discussion Papers.
  15. Vivek Ghosal, 2003. "Firm and Establishment Volatility: The Role of Sunk Costs, Profit Uncertainty and Technological Change," CESifo Working Paper Series 980, CESifo Group Munich.
  16. Del Monte, Alfredo & Papagni, Erasmo, 2003. "R&D and the growth of firms: empirical analysis of a panel of Italian firms," Research Policy, Elsevier, vol. 32(6), pages 1003-1014, June.
  17. White, Lawrence J, 1981. "What Has Been Happening to Aggregate Concentration in the United States?," Journal of Industrial Economics, Wiley Blackwell, vol. 29(3), pages 223-30, March.
  18. Hagerman, Robert L & Senbet, Lemma W, 1976. "A Test of Accounting Bias and Market Structure," The Journal of Business, University of Chicago Press, vol. 49(4), pages 509-14, October.
  19. Zmijewski, Mark E. & Hagerman, Robert L., 1981. "An income strategy approach to the positive theory of accounting standard setting/choice," Journal of Accounting and Economics, Elsevier, vol. 3(2), pages 129-149, August.
  20. Xavier Gabaix, 1999. "Zipf's Law for Cities: An Explanation," The Quarterly Journal of Economics, Oxford University Press, vol. 114(3), pages 739-767.
  21. Ghosal, Vivek, 1996. "Does uncertainty influence the number of firms in an industry?," Economics Letters, Elsevier, vol. 50(2), pages 229-236, February.
  22. Kessides, Ioannis N, 1986. "Advertising, Sunk Costs, and Barriers to Entry," The Review of Economics and Statistics, MIT Press, vol. 68(1), pages 84-95, February.
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Cited by:

  1. Werner Hölzl, 2012. "Mobility Barriers and the Speed of Market Selection," WIFO Working Papers 437, WIFO.
  2. Borchert, Ingo & Gootiiz, Batshur & Grover, Arti & Mattoo, Aaditya, 2012. "Landlocked or policy locked ? how services trade protection deepens economic isolation," Policy Research Working Paper Series 5942, The World Bank.
  3. Pierre Blanchard & Jean-Pierre Huiban & Claude Mathieu, 2012. "The determinants of firm exit in the French food industries," Review of Agricultural and Environmental Studies - Revue d'Etudes en Agriculture et Environnement, INRA Department of Economics, vol. 93(2), pages 193-212.

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