Endogenous Stackelberg Leadership

CentER, Tilburg University, P.O. Box 90153, 5000 LE, Tilburg, The Netherlands; Department of Economics, Universitat Pompeu Fabra, Ramon Trias Fargas 25-27, 08005, Barcelona, Spain
Games and Economic Behavior (Impact Factor: 0.83). 07/1999; DOI: 10.1006/game.1998.0687
Source: CiteSeer

ABSTRACT We consider a linear quantity setting duopoly game and analyze which of the players will commit when both players have the possibility to do so. To that end, we study a two-stage game in which each player can either commit to a quantity in stage 1 or wait till stage 2. We show that committing is more risky for the high cost firm and that, consequently, risk dominance considerations, as in Harsanyi and Selten (1988), allow the conclusion that only the low cost firm will choose to commit. Hence, the low cost firm will emerge as the endogenous Stackelberg leader. Journal of Economic Literature Classification Numbers: C72, D43.

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    ABSTRACT: This paper introduces a continuous-time real options game to study firms' incentives in capacity preemption. Unlike previous literature usually predicting that the endogenous Stackelberg leader is better off by building a larger capacity than its follower, this paper shows that under fairly general conditions, especially if the market exhibits evolving uncertainty, the first entrant prefers to invest in a smaller capacity so it can credibly preempt its competitor. If it had chosen the larger capacity, its competitor could, and in fact would use a smaller plant to force it out of the market. Further, in contrast to the conventional wisdom, preemption does not destroy option value because both the leader and the follower are able to enter the market at their optimal entry date associated with their chosen capacity. However, competition for Stackelberg leadership results in firms' sizes much smaller than required by welfare maximizing.

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