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on Industrial Competition |
| By: | Robert S. Pindyck |
| Abstract: | In merger analysis and other antitrust settings, risk is often cited as a potential barrier to entry. But there is little consensus as to the kinds of risk that matter - systematic versus non-systematic and industry-wide versus firm-specific - and the mechanisms through which they affect entry. I show how and to what extent different kinds of risk magnify the deterrent effect of exogenous sunk costs of entry, and thereby affect industry dynamics, concentration, and equilibrium market prices. To do this, I develop a measure of the "full," i.e., risk-adjusted, sunk cost of entry. I show that for reasonable parameter values, the full sunk cost is far larger than the direct measure of sunk cost typically used to analyze markets. |
| JEL: | D43 L10 L40 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14755&r=com |
| By: | Bekkers, Eddy; Francois, Joseph |
| Abstract: | We develop a model with endogeneity in key features of industrial structure linked to heterogeneous cost structures under Cournot competition. We use the model to explore issues related to cross-country differences in industry structure and the impact of globalization on markups and pricing, concentration, and productivity. The model nests two workhorse trade models, the Brander & Krugman reciprocal dumping model and the Ricardian technology-based trade model, as special cases. We examine both free entry and limited entry (free exit) cases. The model generates clear testable predictions on the probability of zero trade flows and the pattern of export prices, and on cross-country and industry variations in industrial structure controlling for openness. Market prices decline as a result of trade liberalization, the least productive firms get squeezed out of the market, exporting firms gain market share, and more firms become trade oriented. In addition, depending on the strength of underlying cost heterogeneity, falling prices are consistent with both increasing and falling industry concentration following episodes of integration. Welfare rises with trade liberalization, unless trade costs decline from a prohibitive level in the short run free exit case. Variation across industries and markets in markups, concentration, and pricing structures is otherwise a function of market size and the variation in cost heterogeneity across industries. |
| Keywords: | Composition effects of trade liberalization; Cournot competition; Industry structure and firm heterogeneity |
| JEL: | F12 L11 L13 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6956&r=com |
| By: | Vives, Xavier |
| Abstract: | A Bayesian supply function equilibrium is characterized in a market where firms have private information about their uncertain costs. It is found that with supply function competition, and in contrast to Bayesian Cournot competition, competitiveness is affected by the parameters of the information structure: supply functions are steeper with more noise in the private signals or more correlation among the costs parameters. In fact, for large values of noise or correlation supply functions are downward sloping, margins are larger than the Cournot ones, and as we approach the common value case they tend to the collusive level. Furthermore, competition in supply functions aggregates the dispersed information of firms (the equilibrium is privately revealing) while Cournot competition does not. The implication is that with the former the only source of deadweight loss is market power while with the latter we have to add private information. As the market grows large the equilibrium becomes competitive and we obtain an approximation to how many competitors are needed to have a certain degree of competitiveness. |
| Keywords: | adverse selection; collusion; competitiveness; imperfect competition; rational expectations; welfare |
| JEL: | D44 D82 L13 L94 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6960&r=com |
| By: | Emons, Winand; Fluet, Claude |
| Abstract: | Two firms produce a product with a horizontal and a vertical characteristic. We call the vertical characteristic quality. The difference in the quality levels determines how the firms share the market. Firms know the quality levels, consumers do not. Under non-comparative advertising a firm may signal its own quality. Under comparative advertising firms may signal the quality differential. In both scenarios the firms may attempt to mislead at a cost. If firms advertise, in both scenarios equilibria are revealing. Under comparative advertising the firms never advertise together which they may do under non-comparative advertising. |
| Keywords: | advertising; costly state falsification; signalling |
| JEL: | D82 K41 K42 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7109&r=com |
| By: | Brekke, Kurt Richard; Cellini, Roberto; Siciliani, Luigi; Straume, Odd Rune |
| Abstract: | We investigate the effect of competition on quality in regulated markets (e.g., health care, higher education, public utilities), using a Hotelling framework, in the presence of sluggish demand. We take a differential game approach, and derive the open-loop solution (providers commit to an optimal investment plan at the initial period) and the feedback closed-loop solution (providers move investments in response to the dynamics of the states). If the marginal cost of provision is increasing, the steady state quality is higher under the open- loop solution than under the closed-loop solution. Fiercer competition (lower transportation costs and/or less sluggish demand) leads to higher quality in both solutions, but the quality response to increased competition is weaker when players use closed-loop strategies. In both solutions, quality and demand move in opposite directions over time on the equilibrium path to the steady state. |
| Keywords: | competition; quality; Regulated markets |
| JEL: | H42 I11 I18 L13 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6938&r=com |
| By: | Antonio Cabrales; Piero Gottardi |
| Abstract: | In this paper we study, within a formal model, market environments where information is costly to acquire and is of use also to potential competitors. Agents may then sell, or buy, reports over the information acquired and choose the trades in the market on the basis of what they learnt. Reports are unverifiable - cheap talk messages - hence the quality of the information transmitted depends on the conflicts of interest faced by the senders. We find that, in equilibrium, information is acquired when its costs are not too high and in that case it is also sold, though reports are typically noisy. Also, the market for information tends to be a monopoly, and there is inefficiency given by underinvestment in information acquisition. Regulatory interventions in the form of firewalls, limiting the access to the sale of information to agents uninterested in trading the underlying object, only make the inefficiency worse. Efficiency can be attained with a monopolist selling differentiated information, provided entry is blocked. The above findings hold when information has a prevalent horizontal differentiation component. When the vertical differentiation element is more important firewalls can in fact be beneficial. |
| Keywords: | Information sale, Cheap talk, Conflicts of interest, Information Acquisition, Firewalls, Market efficiency |
| JEL: | D83 C72 G14 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/11&r=com |
| By: | Giroud, Xavier; Mueller, Holger M |
| Abstract: | This paper examines the hypothesis that firms in competitive industries should benefit relatively less from good governance, while firms in non-competitive industries--where lack of competitive pressure fails to enforce discipline on managers--should benefit relatively more. Whether we look at the effects of governance on long-horizon stock returns, firm value, or operating performance, we consistently find the same pattern: The effect is monotonic in the degree of competition, it is small and insignificant in competitive industries, and it is large and significant in non-competitive industries. By implication, the effect of governance (in non-competitive industries) reported in this paper is stronger than what has been previously reported in Gompers, Ishii, and Metrick (2003, "GIM") and subsequent work, who document the average effect across all industries. For instance, GIM’s hedge portfolio - provided it only includes firms in non-competitive industries -earns a monthly alpha of 1.47%, which is twice as large as the alpha reported in GIM. The alpha remains large and significant even if the sample period is extended until 2006. We also revisit the argument that investors in the 1990s anticipated the effect of governance, implying that the alpha earned by GIM’s hedge portfolio is likely due to an omitted risk factor. We find that while investors were indeed not surprised on average, they underestimated the effect of governance in non-competitive industries, the very industries in which governance has a significant effect in the first place. |
| Keywords: | Corporate Governance; G-index; Product Market Competition |
| JEL: | D4 G3 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6974&r=com |
| By: | Siddiqi, Hammad |
| Abstract: | Mullainathan, Schwartzstein, & Shleifer [Quarterly Journal of Economics, May 2008] put forward a model of coarse thinking. The essential idea behind coarse thinking is that agents put situations into categories and then apply the same model of inference to all situations in a given category. We extend the argument to strategies in a game-theoretic setting and propose the following: Agents split the choice-space into categories in comparison with salient choices and then choose each option in a given category with equal probability. We provide an alternative explanation for the puzzling results obtained in a Bertrand competition experiment as reported in Abbink & Brandts [Games and Economic Behavior, 63, 2008] |
| Keywords: | Laboratory experiments; Oligopoly; Price competition; Co-ordination games; Coarse Thinking |
| JEL: | L13 C90 D83 D43 C72 |
| Date: | 2009–02–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:13516&r=com |
| By: | Bonnet, Céline; Dubois, Pierre |
| Abstract: | A methodology is presented allowing manufacturers and retailers vertical contracting in their pricing strategies on a differentiated product market to be introduced. This contribution allows price-cost margins to be recovered from estimates of demand parameters both under linear pricing models and two part tariffs. Two types of nonlinear pricing relationships, one where resale price maintenance is used with two part tariffs contracts and one where no resale price maintenance is allowed in two part tariff contracts in particular are considered. The methodology then allows different hypotheses on contracting and pricing relationships between manufacturers and retailers in the supermarket industry to be tested using exogenous variables supposed to shift the marginal costs of production and distribution. This method is applied empirically to study the retail market bottled water in France. Our empirical evidence shows that manufacturers and retailers use nonlinear pricing contracts and in particular two part tariff contracts with resale price maintenance. Finally, using the estimation of our structural model, some simulations of counterfactual policy experiments are introduced. |
| Keywords: | collusion; competition; differentiated products; double marginalization; manufacturers; non nested tests; retailers; two part tariffs; vertical contracts; water |
| JEL: | C12 C33 L13 L81 |
| Date: | 2008–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6918&r=com |
| By: | Schmidt, Klaus M. |
| Abstract: | Many high technology goods are based on standards that require access to several patents that are owned by different IP holders. We investigate the royalties chosen by IP holders under different market structures. Vertical integration of an IP holder and a downstream producer solves the double mark-up problem between these firms. Nevertheless, it may raise royalty rates and reduce output as compared to non-integration. Horizontal integration of IP holders (or a patent pool) solves the complements problem but not the double mark-up problem. Vertical integration discourages entry and reduces innovation incentives, while horizontal integration always encourages entry and innovation. |
| Keywords: | complementary patents; IP rights; licensing; patent pool; standards; vertical integration |
| JEL: | K11 L15 L24 O31 O32 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7005&r=com |
| By: | Galasso, Alberto; Schankerman, Mark |
| Abstract: | We study how fragmentation of patent rights (‘patent thickets’) and the formation of the Court of Appeal for the Federal Circuit (CAFC) affected the duration of patent disputes, and thus the speed of technology diffusion through licensing. We develop a model of patent litigation which predicts faster settlement agreements when patent rights are fragmented and when there is less uncertainty about court outcomes, as was associated with the ‘pro-patent shift’ of CAFC. The model also predicts that the impact of fragmentation on settlement duration should be smaller under CAFC. We confirm these predictions empirically using a dataset that covers nearly all patent suits in U.S. federal district courts during the period 1975-2000. Finally, we analyze how fragmentation affects total settlement delay, taking into account both reduction in duration per dispute and the increase in the number of required patent negotiations associated with patent thickets. |
| Keywords: | anti-commons; litigation; patent thickets; patents; settlement |
| JEL: | K41 L24 O31 O34 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6946&r=com |
| By: | Nocke, Volker; Whinston, Michael |
| Abstract: | We analyze the optimal dynamic policy of an antitrust authority towards horizontal mergers when merger proposals are endogenous and occur over time. Approving a currently proposed merger will affect the profitability and welfare effects of potential future mergers, the characteristics of which may not yet be known to the antitrust authority. We show that, in many cases, this apparently difficult problem has a simple resolution: an antitrust authority can maximize discounted consumer surplus by using a completely myopic merger review policy that approves a merger today if and only if it does not lower consumer surplus given the current market structure. |
| Keywords: | efficiency gain; horizontal merger; market power; merger policy; oligopoly |
| JEL: | D43 L13 L41 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7077&r=com |
| By: | Boone, Jan; Müller, Wieland |
| Abstract: | We consider a vertically related industry and analyze how the total harm due to a price increase upstream is distributed over downstream firms and final consumers. For this purpose, we develop a general model without making specific assumptions regarding demand, costs, or the mode of competition. We consider both the case of homogeneous and differentiated goods markets. Furthermore, we discuss data requirements and suggest explicit formulas and regression specifications that can be used to estimate the relevant terms in the harm distribution in practice, even if elevated upstream prices are rather constant over time. The latter can be achieved by considering perturbations of the demand curve. This in turn can be used to construct a supply curve for the case of imperfect competition that includes perfect competition and monopoly as special cases. Finally, we illustrate how basic intuition from the tax incidence literature carries over to the distribution of harm. |
| Keywords: | abuse of a dominant position; apportionment of harm; cartel; pass on defense; supply curve; tax incidence |
| JEL: | D43 L13 L42 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6949&r=com |
| By: | Miao, Chun-Hui |
| Abstract: | According to the hypothesis of planned obsolescence, a durable goods monopolist without commitment power has an excessive incentive to introduce new products that make old units obsolete, and this reduces its overall profitability. In this paper, I reconsider the above hypothesis by examining the role of competition in a monopolist's upgrade decision. I find that, when a system add-on is competitively supplied, a monopolist chooses to tie the add-on to a new system that is only backward compatible, even if a commitment of not introducing the new system is available and socially optimal. Tying facilitates a price squeeze. |
| Keywords: | Compatibility; Durable Goods; Network Externalities; Planned Obsolescence; Tying. |
| JEL: | L12 L40 |
| Date: | 2008–12–31 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:13523&r=com |
| By: | Gallice, Andrea |
| Abstract: | According to standard IO models, the characteristics of market demand (intercept, slope, elasticity) and of the technology (level of symmetric marginal costs) do not play any role in defining the sustainability of collusive behaviors in Bertrand oligopolies. The paper modifies this counterintuitive result by showing that all the above mentioned factors do affect the sustainability of collusion when prices are assumed to be discrete rather than continuous. The sign of these effects is unambiguous. Their magnitude varies greatly: in some cases it is totally negligible, in others it becomes extremely relevant. |
| Keywords: | Bertrand supergames; collusion; market demand |
| JEL: | L13 L41 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6975&r=com |
| By: | David Bartolini (Universit… Politecnica delle Marche, Department of Economics, MoFiR); Alberto Zazzaro (Universit… Politecnica delle Marche, Department of Economics, MoFiR) |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:anc:wmofir:18&r=com |
| By: | Louis S. Thompson |
| Abstract: | This paper looks in detail at the cases of two countries that exhibit extreme cases of transport organization. In both countries, the railway and most of the ports are under unitary control, with essentially no regulation and only limited information available to assess behavior. If economies of scale are important, if the “integration” achieved by organizational unification is truly beneficial, and if competition is not needed to limit the behavior of the unified organizations, then these countries should be at the cutting edge of system performance, with high efficiency, low costs and excellent service. If the reverse is true, then they furnish at least a few data points for the analysis of the importance of diversity of organization and competition within the system. |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:oec:itfaaa:2009/5-en&r=com |
| By: | Simon Pilsbury; Andrew Meaney |
| Abstract: | This report examines market power in rail markets in Europe arising from horizontal and vertical mergers in the sector, and is intended to provide a high-level basis for discussion at the round table itself. It presents factual information on horizontal and vertical merger cases involving rail freight operators, highlighting the processes used by competition authorities to determine the circumstances in which such mergers should be approved. It also provides commentary on the economics of these markets and, hence, the likely prospects for their future shape. The topic of the report is timely. The first set of results are available from a preparatory study for the European Commission on whether policy objectives with respect to moving freight onto rail can best be achieved by giving freight more priority on the rail network. |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:oec:itfaaa:2009/4-en&r=com |
| By: | Cantillon, Estelle; Yin, Pai-Ling |
| Abstract: | In a famous episode of financial history which lasted over eight years, the market for the future on the Bund moved entirely from LIFFE, the incumbent London-based derivatives exchange, to DTB, the entering Frankfurt-based exchange. This paper studies the determinants of traders' exchange choice, using a novel panel dataset that contains individual trading firms' membership status at each exchange together with other firms characteristics and pricing, marketing and product portfolio strategies by each exchange. Our data allows us to evaluate different sources of heterogeneity among trading firms and thus distinguish between different explanations for the observed phenomenon. The story the data tells is one of horizontal differentiation and vertical differentiation through liquidity. As a result, DTB attracted a different set of traders than LIFFE, and those traders contributed to the market share reversal. |
| Keywords: | intermediation; multi-homing; network effects; platform competition; tipping |
| JEL: | D4 |
| Date: | 2008–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6923&r=com |
| By: | Cleeren, Kathleen; Dekimpe, Marnik G.; Gielens, Katrijn; Verboven, Frank |
| Abstract: | The price-aggressive discount format, popularized by chains such as Aldi and Lidl, is very successful in most Western economies. Its success is a major source of concern for traditional supermarkets. Discounters not only have a direct effect on supermarkets’ market shares, they also exert considerable pressure to improve operational efficiency and/or to decrease prices. We use an empirical entry model to study the degree of intra- and inter-format competition between discounters and supermarkets. Information on the competitive impact of new entrants is derived from the observed entry decisions of supermarkets and discounters in a large cross-section of local markets, after controlling for a number of local market characteristics. In our modeling framework, we endogenize the retailers’ entry decisions, and allow for asymmetric intra- and inter-format competitive effects in a flexible way. We apply our modeling approach to the German grocery industry, where the discount format has stabilized after two decades of continued growth. We find evidence of intense competition within both the supermarket and discounter format, although competition between supermarkets is found to be more severe. Most importantly, discounters only start to affect the profitability of conventional supermarkets from the third entrant onwards. This may explain why many retailers rush to add a discount chain to their portfolio: early entrants may benefit from the growth of the discount-prone segment without cannibalizing the profits of their more conventional supermarket stores. |
| Keywords: | empirical entry models; hard discounters; supermarket competition |
| JEL: | L10 M30 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6964&r=com |
| By: | Kaniska Dam; Marc Escrihuela-Villar; Santiago Sanchez-Pages |
| Abstract: | We analyse risk-taking behaviour of banks in the context of spatial competition. Banks mobilise unsecured deposits by offering deposit rates, which they invest either in a prudent or a gambling asset. Limited liability along with high return of a successful gamble induce moral hazard at the bank level. We show that when the market power is low, banks invest in the gambling asset. On the other hand, for sufficiently high levels of market power, all banks choose the prudent asset to invest in. We further show that a merger of two neighboring banks increases the likelihood of prudent behaviour. Finally, introduction of a deposit insurance scheme exacerbates banks’ moral hazard problem. |
| JEL: | D43 G28 G34 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:edn:esedps:187&r=com |
| By: | Pascal Courty; Mario Pagliero |
| Abstract: | Concert tickets can either be sold at a single price or at different prices to reflect the various levels of seating categories available. Here we consider how two product characteristics (the artist's age and venue capacity) influence the likelihood that pop music concert tickets will be sold at different prices. We argue that valuation heterogeneity, and thus the returns to using price discrimination, are higher for older artists and in larger venues. We test this hypothesis in a large dataset of concerts. By singling out variations in the two characteristics that are exogenous to the decision to price discriminate, we show that these characteristics have a large and significant impact on the use of price discrimination. |
| Keywords: | Price discrimination, second degree price discrimination, profit maximization |
| JEL: | D42 L82 Z11 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/05&r=com |
| By: | Iwan Bos (University of Amsterdam); Maarten Pieter Schinkel (University of Amsterdam) |
| Abstract: | Basing-point pricing is known to have been abused by geographically dispersed firms in order to eliminate competition on transportation costs. This paper develops a topographic test for collusive basing-point pricing. The method uses transaction data (prices, quantities) and customer project site locations to recover the basing-point(s) from which delivered prices were calculated. These bases are compared to the locations of the production mills in a test that discriminates between competitive and collusive basing-point pricing. We define a measure for the likelihood of collusion that can be used to screen industries that traditionally apply delivered pricing for the presence of cartels. We operationalize this screen with a software. The test is hard to beat for cartels using this otherwise elusive form of price-fixing. When a cartel was found to have abused the basing-point system, our method can be used to estimate antitrust damages. |
| Keywords: | basing-point pricing; cartels; detection; antitrust; damages |
| JEL: | L41 K42 C12 |
| Date: | 2009–01–20 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20090007&r=com |
| By: | Baldwin, Richard; Ito, Tadashi |
| Abstract: | Based on the recent trade models of the Heterogeneous Firms Trade (HFT) model and the Quality Heterogeneous Firms Trade (QHFT) model, we classify export goods (at the HS 6-digit level of disaggregation) by quality and price competition. We find a high proportions of quality-competition goods for the major EU countries and lower proportions for Canada, Australia and China. However, the overlap of these quality-competition goods is not large, which suggests that characteristics of export goods are substantially different across countries at the same HS 6-digit code. |
| Keywords: | heterogeneous firms trade model; Quality vs Price competition |
| JEL: | F14 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6952&r=com |
| By: | Van Beers, Cees; Dekker, Ronald |
| Abstract: | This aim of this paper is twofold. First it examines the determinants of acquisitions and divestitures of Dutch firms in the period 1996-2004. Second, it investigates the impact of acquisitions and divestitures on the firm’s innovative output performance. An econometric model is specified and estimated with Community Innovation Survey data for the Netherlands in the period 1996-2004. The main findings of this study are as follows. First, innovating firms are significantly more involved in acquisition activities than non-innovating firms, which suggests that acquisitions are a strategy to gain access to new technologies or knowledge. Second, lack of knowledge as a barrier to innovate increases the chance of acquiring assets of other firms although not significantly. Lack of finance as a barrier to innovate increases significantly the chance of divesting assets. Third, acquisitions motivated by knowledge barriers in the innovation process affect the probability of positive innovative sales positively while acquisitions motivated by other reasons than innovation barriers affect this probability negatively. No effect of knowledge barriers induced acquisitions on the level of the innovative sales could be found. |
| Keywords: | Innovation; performance; mergers; acquisitions; divestitures; strategy. |
| JEL: | L10 D40 |
| Date: | 2009–02–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:13464&r=com |
| By: | Praveen Kujal (Universidad Carlos III de Madrid); Juan Ruiz (Banco de España) |
| Abstract: | This paper highlights the importance of product differentiation and endogenous R&D in determining the optimal R&D policy, in a model where investment in cost reducing R&D is committed before firms compete in a differentiated-goods third-country export market. R&D is always taxed in oligopolies for high degrees of product differentiation. For lower degrees of product differentiation the duopoly is subsidized or the government remains inactive. In contrast, the monopoly is always subsidized. The government with a duopoly may be active or inactive depending on the degree of product differentiation. Thus, we may observe a reversal in the sign of the optimal R&D policy if the degree of product differentiation changes or, alternatively, if there is a change in the number of firms. Similar qualitative results hold if trade policy uses output subsidies, instead of R&D promotion. |
| Keywords: | product differentiation, strategic trade policy, policy reversals, r&d subsidies, monopoly, duopoly |
| JEL: | F12 F13 L13 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:0901&r=com |
| By: | Franklin Allen; Elena Carletti; Robert Marquez |
| Abstract: | It is commonly believed that equity finance for banks is more costly than deposits. This suggests that banks should economize on the use of equity and regulatory constraints on capital should be binding. Empirical evidence suggests that in fact this is not the case. Banks in many countries hold capital well in excess of regulatory minimums and do not change their holdings in response to regulatory changes. We present a simple model of bank moral hazard that is consistent with this observation. In perfectly competitive markets, banks can find it optimal to use costly capital rather than the interest rate on the loan to guarantee monitoring because it allows higher borrower surplus. |
| Keywords: | credit market competition, monitoring, loan rates, capital, bank monitoring |
| JEL: | G21 G31 D4 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/08&r=com |