Working Paper: NBER ID: w14755
Authors: 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.
Keywords: sunk costs; risk; barriers to entry; market structure; antitrust
JEL Codes: D43; L10; L40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| systematic and idiosyncratic risks (D80) | sunk costs (G31) |
| sunk costs (G31) | barriers to entry (D43) |
| aggregate risk (E10) | asymmetric distribution of returns (D39) |
| asymmetric distribution of returns (D39) | potential profitability of entry (F23) |
| full risk-adjusted sunk cost (G31) | direct sunk cost (G31) |
| nature and extent of risks (G22) | entry timing (Y20) |
| nature and extent of risks (G22) | evolution of market prices (D41) |
| aggregate and idiosyncratic risks (D80) | entry profitability (M21) |
| aggregate and idiosyncratic risks (D80) | market structure (D49) |