Issue 1

Volume 15 JOURNAL OF ECONOMICS & MANAGEMENT STRATEGY
Spring 2006

Real Options in an Asymmetric Duopoly: Who Benefits from Your Competitive Disadvantage?

Grzegorz Pawlina and Peter M. Kort
This paper analyzes the impact of investment cost asymmetry on the optimal real option exercise strategies and the value of firms in duopoly. Both firms have an opportunity to invest in a project enhancing (ceteris paribus) the profit flow. We show that three types of equilibrium strategies exist. Furthermore, we express the critical levels of cost asymmetry delineating the equilibrium regions as functions of basic economic variables. The presence of strategic interactions among the firms leads to counterintuitive results. First, for a certain range of the asymmetry level, a marginal increase in the investment cost of the firm with the cost disadvantage can enhance this firm's own value. Moreover, such a cost increase can reduce the value of the competitor. Finally, we discuss the welfare implications of the optimal exercise strategies and show that the presence of identical firms can result in a socially less desirable outcome than if one of the competitors has a significant cost (dis)advantage.

Dynamic Competition with Experience Goods

J. Miguel Villas-Boas
This paper considers dynamic competition in the case in which consumers are only able to learn about their preferences for a certain product after experiencing it. After trying a product a consumer has more information about that product than about untried products. When competing in such a market firms with more sales in the past have an informational advantage because more consumers know their products. If products provide a better-than-expected fit with greater likelihood, taking advantage of that informational advantage may lead to an informational disadvantage in the future. This paper considers this competition with an infinite horizon model in a duopoly market with overlapping generations of consumers. Two effects are identified: On one hand marginal forward-looking consumers realize that by purchasing a product in the current period will be charged a higher expected price in the future. This effect results in reduced price sensitivity and higher equilibrium prices. On the other hand, forward-looking firms realize that they gain in the future from having a greater market share in the current period and compete more aggressively in prices. For similar discount factors for consumers and firms, the former effect is more important, and prices are higher the greater the informational advantages. The paper also characterizes oscillating market share dynamics, and comparative statics of the equilibrium with respect to consumer and firm patience, and the importance of the experience in the ex post valuation of the product.

Nationalism in Winter Sports Judging and Its Lessons for Organizational Decision Making

Eric Zitzewitz
This paper exploits nationalistic biases in Olympic winter sports judging to study the problem of designing a decision-making process that uses the input of potentially biased agents. Judges score athletes from their own countries higher than other judges do, and they appear to vary their biases strategically in response to the stakes, the scrutiny given the event, and the degree of subjectivity of the performance aspect being scored. Ski jumping judges display a taste for fairness in that they compensate for the nationalistic biases of other panel members, while figure skating judges appear to engage in vote trading and bloc judging. Career concerns create incentives for judges: biased judges are less likely to be chosen to judge the Olympics in ski jumping but more likely in figure skating; this is consistent with judges being chosen centrally in ski jumping and by national federations in figure skating. The sports truncate extreme scores to different degrees; both ski jumping and, especially, figure skating are shown to truncate too aggressively. Extreme truncation not only discards information, but may also make the vote trading in figure skating easier to implement. These findings have implications for both the current proposals for reforming the judging of figure skating and for designing decision making in organizations more generally.

Marketing Innovation

Yongmin Chen
This paper provides an economic analysis of marketing innovation. A dynamic duopoly model is developed to study two forms of marketing innovation: γ, which allows a firm to acquire consumer information effectively; and σ, which reduces consumer transaction costs. The incentives and effects of marketing innovation differ markedly from those of product or process innovations. Although γ benefits the innovating firm, it hurts some consumers; and, while σ benefits all consumers, it may or may not benefit the innovating firm. Increased competition intensity reduces the value of γ but increases the value of σ. The private incentive is too high for γ but too low for σ.

Consumer Cognition and Pricing in the Nines in Oligopolistic Markets

Kaushik Basu
The paper fully characterizes the Bertrand equilibria of oligopolistic markets where consumers may ignore the last (i.e., the right-most) digits of prices. Consumers, in this model, do not do this reflexively or out of irrationality, but only when they expect the time cost of acquiring full cognizance of the exact price to exceed the expected loss caused by the slightly erroneous amounts that are likely to be purchased or the slightly higher price that may be paid by virtue of ignoring the information concerning the last digits of prices. It is shown that in this setting there will always exist firms that set prices that end in nine though there may also be some (nonstrict) equilibria where a non-nine price ending occurs. It is shown that all firms earn positive profits even in Bertrand equilibria. The model helps us understand in what kinds of markets we are most likely to encounter pricing in the nines.

Unbeatable Value Low-Price Guarantee: Collusive Mechanism or Advertising Strategy?

Juan A. Mañez
This paper investigates the effects of a low-price guarantee (price-beating guarantee) on the patterns of price setting of three supermarkets using micro-level price data. Following recent theoretical developments, the paper analyzes the ability of low-price guarantees to sustain anticompetitive prices. My empirical analysis suggests instead that this low-price guarantee may serve as an advertising device to signal low prices. The supermarket offering the low-price guarantee, aware of its price advantage in a subset of products, uses it to signal low prices to induce consumers to switch supermarkets.

Entry-Deterring Capacity in the Texas Lodging Industry

Michael Conlin and Vrinda Kadiyali
This paper empirically tests whether capacity is used to deter entry and whether the amount invested in entry-deterring capacity is related to market concentration and market presence. We use a unique dataset containing 3,830 lodging properties in Texas from 1991 through 1997. We find that there is higher investment in capacity relative to demand (i.e., idle capacity) in markets with a larger Herfindahl index and by firms with a larger share of market capacity. These results are consistent with the entry deterrence literature that suggests firms in more concentrated markets and firms with a larger market share have greater incentive to invest in entry-deterring capacity.

Team Incentives under Relative Performance Evaluation

Junichiro Ishida
This paper examines the optimal provision of incentives in the repeated setting with many agents under the restriction that only relative performance evaluation is feasible for contracting. We show that the optimal contract in the repeated setting may take a different form than that in the static setting. In the repeated setting, it may be optimal for the principal to arbitrarily divide the agents into teams and compensate them based on team ranking, as it allows the principal to motivate the agents through peer sanctions. The situation draws a clear contrast to the static setting where such a strategy is never optimal. The result indicates that the concept of team plays an important role in the repeated setting even when performances can only be evaluated in relative terms.

Quality and Location Choices under Price Regulation

Kurt R. Brekke, Robert Nuscheler and Odd Rune Straume
In a model of spatial competition, we analyze the equilibrium outcomes in markets where the product price is exogenous. Using an extended version of the Hotelling model, we assume that firms choose their locations and the quality of the product they supply. We derive the optimal price set by a welfarist regulator. If the regulator can commit to a price prior to the choice of locations, the optimal (second-best) price causes overinvestment in quality and an insufficient degree of horizontal differentiation (compared with the first-best solution) if the transportation cost of consumers is sufficiently high. Under partial commitment, where the regulator is not able to commit prior to location choices, the optimal price induces first-best quality, but horizontal differentiation is inefficiently high.

Defensive Publications in an R&D Race

Talia Bar
This paper considers a multistage dynamic R&D race in which the competitors strategically publish research findings. Publications change the prior art, thus affecting patentability. Firms publish when they are behind in the race and their rival is close to winning it. Publication sets back both competitors and gives the follower a chance to catch up. Publications prolong the race. Firms are more likely to publish the more patient they are, and the higher their probability of success. Asymmetry between the firms generates additional incentives to publish such as protecting profits from a previous patent and increasing a strong firm's probability of winning. When firms face a joint decision on publications and the intensity of research, publications substitute investment.