Issue 1

Volume 22 JOURNAL OF ECONOMICS & MANAGEMENT STRATEGY
Spring 2013

Product Differentiation through Exclusivity: Is there a One-Market-Power-Rent Theorem?

Benjamin E. Hermalin and Michael L. Katz
In systems industries, combinations of components are consumed together to generate user benefits. Arrangements among component providers sometimes limit consumers’ ability to mix-and-match components, and such exclusive arrangements have been highly controversial. We examine the competitive and welfare effects of exclusive arrangements among system components in a model of relatively differentiated applications that run on relatively undifferentiated platforms. We show that there is no “One-Market-Power-Rent Theorem.” Specifically, exclusive deals with providers of differentiated applications can raise platforms’ margins without reducing applications’ margins, so that overall industry profits rise. Hence, for a given set of components and prices, exclusive arrangements can reduce consumer welfare by limiting consumer choice and raising equilibrium prices. In some cases, however, exclusivity can raise consumer welfare by increasing the equilibrium number of platforms, which leads to lower prices relative to the monopoly outcome that would prevail absent exclusivity.

Cross-Border Merger & Acquisition Activity and Revealed Comparative Advantage in Manufacturing Industries

Steven Brakman, Harry Garretsen, Charles Van Marrewijk, and Arjen Van Witteloostuijn
We estimate an important implication of oligopolistic international trade modeling for the predicted pattern of cross-border mergers and acquisitions (M&As). Our core argument is that cross-border M&As are, among other factors, driven by cross-country differences in comparative advantage. We find strong evidence that acquiring firms operate in industries with a comparative advantage. We also report (less pronounced) evidence that this holds for target firms as well. We therefore add another explanation, rooted in international economics, to the industrial organization literature on M&As that emphasizes efficiency and strategic motives.

Salience in Quality Disclosure: Evidence from the U.S. News College Rankings

Michael Luca and Jonathan Smith
This paper investigates the impact of college rankings, and the visibility of those rankings, on students’ application decisions. Using natural experiments from U.S. News and World Report College Rankings, we present two main findings. First, we identify a causal impact of rankings on application decisions. When explicit rankings of colleges are published in U.S. News, a one-rank improvement leads to a 1-percentage-point increase in the number of applications to that college. Second, we show that the response to the information represented in rankings depends on the way in which that information is presented. Rankings have no effect on application decisions when colleges are listed alphabetically, even when readers are provided data on college quality and the methodology used to calculate rankings. This finding provides evidence that the salience of information is a central determinant of a firm's demand function, even for purchases as large as college attendance.

Sudden Unintended Used-Price Deceleration? The 2009-2010 Toyota Recalls

Robert G. Hammond
Using data from the vehicle resale market, I test consumer responsiveness to large-scale product recalls that are caused by safety problems. The used-vehicle prices of Toyotas are compared to the used-vehicle prices of the other major domestic and foreign manufacturers. The results quantify the losses suffered by Toyota vehicle owners in secondary markets due to the 2009–2010 safety recalls of more than 9 million Toyota Motors vehicles. The treatment effect of a recall is measured using panel data with a difference-in-differences estimation approach that allows for time-varying treatment effects and serial correlation. I find that this recall episode had negative effects in the resale market for automobiles that were quantitatively small (less than 2% of the vehicle’s resale value), statistically indistinguishable from zero, and short lived (did not persist beyond December 2009). A comparison with Audi’s recalls in the 1980s of vehicles with sudden unintended acceleration suggests that the extent to which a company’s reputation is established is more important than whether or not a company has a reputation for producing high-quality products.

A Study of Vertical Integration and Vertical Divestiture: The Case of Store Brand Milk Sourcing in Boston

Michael Al Cohen
This article investigates whether a retailer’s store brand supply source impacts vertical pricing and supply channel profitability. Using chain-level retail scanner data, a random coefficients logit demand model is estimated employing a Bayesian estimation approach. Supply models are specified conditional on demand parameter estimates. Bayesian decision theory is applied to select the best fitting pricing model. Results indicate that a vertically integrated retailer engages in linear pricing for brand manufacturers’ products while competing retailers make nonlinear pricing contracts with brand manufacturers for branded products and store brands. A simulated vertical divestiture based on real world events provides evidence for improved channel efficiency.

Real Asset Valuation under Imperfect Competition: Can We Forget About Market Fundamentals?

Corinne Chaton and Laure Durand-Viel
Real assets are usually valued by computing the stream of profits they can bring to a price-taking firm in a liquid market. This method ignores market fundamentals by assuming that all the relevant information is included in the spot price. Our article analyses the bias resulting from such an approach when the market is imperfectly competitive. We propose a stylized two-period model of the natural gas market with no uncertainty, focusing on strategic interactions between two types of oligopolistic players—pure traders and suppliers with downstream customers—who have access to storage. We show that the true value of storage capacity is not the same for traders and for suppliers. Comparing the latter value with the traditional price-taking valuation reveals a systematic bias that tends to induce underinvestment.

Information Management and Incentives

Julia Nafziger and Heiner Schumacher
We ask how the incentives of an agent are affected by an information management system that lets the agent receive information about the performance of a colleague before (“transparent firm”) rather than after he provides effort (“nontransparent firm”). Transparency is detrimental for incentives if the performance of the colleague provides information on the relative impact of the agent’s effort on his success probability. The findings imply that firms in which comparisons between employees play a minor role for compensation are transparent. Firms in which they play a major role sometimes choose to be nontransparent despite the flexibility gains transparency provides.

Group Buying Commitment and Sellers’ Competitive Advantages

Yuxin Chen and Xinxin Li
This paper examines a model of duopoly firms selling to an exogenously formed buyer group consisting of members with heterogeneous preferences. Two research questions are addressed: (1) when is it optimal for a buyer group to commit to exclusive purchase from a single seller, and (2) how does the presence of group buying and the exclusive purchase commitment associated with it affect firms’ incentives to invest in quality improvement? We find that, even though exclusive purchase commitment benefits buyers when the competing products provide similar quality, it may lower buyer surplus if one product is significantly advantaged and/or the competing products are not highly differentiated horizontally. This result is robust even if the buyer group is formed endogenously. In addition, contingent on the similarity between the competing sellers’ investment costs, the sellers’ incentives to improve quality may be positively or negatively affected by the presence of group buying.

Second-Price Auctions with Different Participation Costs

Xiaoyong Cao and Guoqiang Tian
This paper studies equilibria of second-price auctions in independent private value environments with different participation costs. Two types of equilibria are identified: monotonic equilibria in which a bidder with a lower participation cost results in a lower cutoff for submitting a bid, and nonmonotonic equilibria in which a lower participation cost results in a higher cutoff. We show that there always exists a monotonic equilibrium, and further, that the monotonic equilibrium is unique for either concave distribution functions or strictly convex distribution functions with nonincreasing reverse hazard rates. There exist nonmonotonic equilibria when the distribution functions are strictly convex and the difference of the participation costs is sufficiently small. We also provide comparative static analysis and study the limiting properties of equilibria when the difference in bidders’ participation costs approaches zero.