Antitrust & Competition Policy Blog

Editor: D. Daniel Sokol
University of Florida
Levin College of Law

Wednesday, March 4, 2009

Sunk Costs and Real Options in Antitrust Analysis

Posted by D. Daniel Sokol

Robert S. Pindyck, MIT Sloan School of Management has a new paper on Sunk Costs and Real Options in Antitrust Analysis.

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.

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