Strategic competition in oligopolies with fluctuating demand. (Q820224)

The aim of this book is to evaluate whether long-term decisions, for example the organization of the production process, the outside financing of investment projects and management compensation increase or decrease the scope for collusion in markets with stable and fluctuating demand. Since the theory of infinitely repeated games offers a concise and insightful description of long-term competition and most often yields analytically tractable results, the author uses such a game framework in presented theoretical analysis. This book extends the literature on long-term strategic competition in two aspects. Firstly, it is considered the effect of such decisions in market with demand fluctuations that quite accurately describe the demand development. Thereby, situations are analyzed where the firms cannot implicitly agree on the monopoly price and have to be content with lower profits from a less restrictive agreement. The author offers a brief discussion of the parallel occurrence of a cyclic trend and random shocks. The combination of a deterministic cyclic trend with periodic trend with periodic, stochastic shocks quite closely represents the actual development of demand in many markets. The presented study demonstrates that the basic working of collusion in the product market is robust to stochastic and cyclic demand changes. Secondly, the author integrates additional long-term decisions into the model of competition without --- a known --- end. These often involve interaction with other individuals apart from horizontal competitors. The author assumes perfect information throughout and concentrates on three long-term business strategies that are empirically prevalent, but did not receive much attention in the literature so far, namely cooperation in production, outside financing by bonds and management compensation. The structure of the book is as follows. Chapter 2 reviews the theoretical literature on the effects of exogenous and endogenous market conditions on collusion. Chapter 3 offers an identically structured survey of the empirical evidence on long-term oligopolistic competition, which complements the review of the theoretical literature. The author focuses on demand fluctuations and the decision on cooperating in production by coordinating capital reinvestments, on external financing as well as on employing and compensating managers to prepare the ground for the subsequent detailed analysis of their impact on competition. The overview of the literature is followed by the theoretical analysis of different strategic decisions in long-term competition in oligopolies with fluctuating demand. In Chapter 4 the author presents the basic framework of infinitely repeated oligopolistic competition. Two types of demand fluctuations are introduced, namely stochastic periodic shocks and recurring deterministic cycles. Since the stochastic shocks are uncorrelated over time, the current realization does not affect the future profits. Contrastingly in the case of a cyclic trend the future development depends on the demand level. Since the punishment for defection from collusion consists in a loss of future profits, the two demand patterns have polar effects on competition in the market. Chapter 5 starts with the very common, but rarely considered decision on reinvestments in the stock of physical capital. The depreciation of production equipment necessitates frequent reinvestments: to keep the production process smooth and costs low, firms regularly replace the worn-out equipment. Cooperation in production hence may consist in the coordination of capital reinvestments. Alternatively, firms may produce in a joint owned plant. The presented study shows that non-cooperative capital reinvestments yield low Nash-competitive profits, whereas cooperation in the investment stage allows for high Nash-competitive profits. The difference between the respective collusive profits is small in comparison. Consequently, the punishment for defection from the implicit agreement is lower if the firms coordinate the reinvestments in the production process. In contrast to warning by antitrust experts, horizontal cooperation in manufacturing hence decreases the scope of collusion compared to the benchmark case without reinvestments. In Chapter 6 the author proceeds in the same manner and integrates the decision on the external financing into the basic model of long-term competition. The presented analysis demonstrates the impact of outside finance on the competitive strategy of firms in long-run competition. The effect of limited liability, i.e. bankruptcy and the resulting inability of equity-holders to repay their debt, proves decisive for the effect of leverage on the intensity of competition in markets with constant as well as with fluctuating demand. If the firms are solvent in unrestrained competition, the repayments are irrespective of whether equity-holders compete, collude or deviate. Hence, the debt level does not change the intensity of competition in the market. In the case of insolvency after a defection, the additional future profit stream from an implicit agreement and thus the potential costs of cheating are lower the higher the repayment is. Consequently, the incentive to collude declines with rising indebtedness. Then, internal financing is the optimal strategy with regard to the viability of collusion. In Chapter 7 the author discusses the effect of delegation of a firm's management. In the context of long-term oligopolistic competition, the design of the manager's compensation schemes proves to be decisive. It is derived the effect of the two most prevalent types of incentive compensation, stock-based remuneration that consists either in share-price dependent payments, stock grants or option grants and more traditional payments that depend on current profits. The incentive to collude proves to be higher if the managers receive stock-based instead of profit-based compensation sine the former puts a higher value on future profits. If the payments are deferred, their pro-collusive impact is even stronger because the profit gained by defection is disbursed when the corresponding payment is made. Chapter 8 summarizes the main results of presented study and discusses the advantages as well as the disadvantages of the presented theoretical framework. References consists of 261 items.