Issue 3

Ozge Turut and Elie Ofek
We model an incumbent’s decision to pursue radical or incremental innovation when facing a rival entrant. The radical innovation may yield lucrative financial returns but entails significant technological and market-related uncertainties. It is also particularly attractive to the rival entrant: if the market for it pans out, such an innovation obsoletes the existing technology and any incremental improvements to it. Each firm has its own assessment of the market potential for the radical innovation, and the reliability of these market forecasts can differ. We show that when the entrant’s market-assessment capability is weak, the incumbent will pursue incremental innovation and postpone its plans to develop radical innovation even when it thinks highly of the market potential for the radical innovation. The incumbent does so to avoid validating the high market potential to the entrant, who may otherwise be encouraged to invest aggressively. The incumbent thus prefers to look “soft” with respect to its innovation strategy in order to discourage entry. Even if its innovation strategy is not observable, we show that an incumbent that assesses the commercial potential for a radical innovation favorably may pursue an incremental path and communicate its plans publicly; this strategy serves to reduce entry by affecting the entrant’s beliefs about the market potential of the innovation. Finally, we extend the model to investigate the entrant’s decision to communicate its innovation intentions. We find that the entrant communicates its plans to aggressively pursue radical innovation only if the incumbent’s market-assessment capabilities are strong. In doing so, the entrant acts preemptively to discourage the incumbent from pursuing the radical innovation, and is less concerned with validating market potential.

Susan Feng Lu
This paper uses a mandatory quality disclosure policy, the Nursing Home Quality Initiative (NHQI), to investigate how quality ‘report cards’ affect firms’ choices of multidimensional product quality. I show that after the introduction of NHQI: (1) scores of quality measures improve for the reported dimensions but deteriorate for the unreported ones; (2) there is no evidence that nursing homes decrease quality-related inputs; (3) consumer demand becomes sensitive to changes in the NHQI quality measures. These findings are consistent with the multitasking hypothesis that firms may respond to information disclosure by reallocating effort across dimensions of quality without necessarily increasing overall quality.

Didier Laussel and Ngo Van Long
In a model where a monopolistic downstream firm (assembler) negotiates simultaneously with each of its intermediate-input suppliers the prices of the complementary components which enter its product, we analyze the process by which the assembler separates from its suppliers as a Markov Perfect equilibrium. Due to a negative strategic effect (the prices and profits of independent suppliers decrease when their number increases), the assembler’s marginal return from keeping an upstream subsidiary is lower than the market value of an independent supplier. Separation is immediate when the downstream firm’s initial number of upstream subsidiaries is below a critical level. It is progressive in the reverse case and eventually leads to a mixed strategy whereby the assembler keeps all the remaining subsidiaries with some probability, and sells all them off in one go with the complementary probability.

Francisco Ruiz-Aliseda and Jianjun Wu
This paper studies entry and exit decisions in markets whose demand alternates between growth and decline phases at uncertain times. We introduce a stochastic process that captures these features of random market evolution, and we provide key mathematical results related to first passage times which make the characterization of entry and exit behavior quite simple and straightforward (even when the process is subject to an endogenously determined upper or lower barrier). We characterize entry and exit patterns in a dynamic competitive equilibrium, and we show why our results differ from those obtained if demand follows a diffusion process (e.g., a Geometric Brownian Motion). Despite the stochastic process of the underlying variable has a continuous sample path in both cases, we demonstrate in our setting that positive rates of entry and exit discontinuously fall to zero owing to informational overshooting. Another advantage of our framework is that it can explain discontinuities in firm values even if sample paths are continuous. Our framework is also amenable to empirical implementations (as we show using Corts’ 2008 offshore oil drilling application), and to an intuitive interpretation of optimal (dis) investment rules based on Bernanke’s (1983) “bad news principle of irreversible investment.”