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Timing Vertical Relationships

Ruble, Richard, Versaevel, Bruno and De Villemeur, Étienne (2010) Timing Vertical Relationships. TSE Working Paper, n. 10-181

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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.

Item Type: Monograph (Working Paper)
Language: English
Date: 23 June 2010
JEL Classification: C73 - Stochastic and Dynamic Games; Evolutionary Games; Repeated Games
D43 - Oligopoly and Other Forms of Market Imperfection
D92 - Intertemporal Firm Choice and Growth, Investment, or Financing
L13 - Oligopoly and Other Imperfect Markets
Divisions: TSE-R (Toulouse)
Site: UT1
Date Deposited: 18 Jan 2012 06:02
Last Modified: 02 Apr 2021 15:36
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