| Abstract: |
We study a manufacturer's demand-investment decisions in distribution channels
subject to double marginalization. Casting this as a mechanism design problem,
we show that demand-enhancing investments strengthen retailers' incentives to
exploit market power, forcing manufacturers to concede greater rents.
Manufacturers therefore optimally restrict product quality or market coverage.
We fully characterize which demand parameters create these perverse
incentives: increases benefit manufacturers in segments where they control
pricing but harm them in segments with binding incentive constraints. This
reveals fundamental limits to demand-side investment in vertical relationships. |