Permission to Exist

NBER Working Paper No. 20512

Issued in September 2014

NBER Program(s):Industrial Organization, Productivity, Innovation, and Entrepreneurship



We provide a new model that generates persistent performance differences amongst seemingly similar enterprises. Our model provides a mechanism whereby efficient incumbent rivals can give permission for an inefficient firm to exist in the presence of efficient entrants. We demonstrate that, in a repeated game, an efficient incumbent has a unilateral incentive to establish a relational contract that softens price competition to either strengthen the inefficient firm in a war of attrition that emerges post-entry or reduce the value to the inefficient firm of selling its position to entrants. The paper provides conditions under which that equilibrium exists and derives a number of empirical predictions as implications of the model. It is demonstrated that performance differences are likely to be associated with stability in the identity of firms in the market.

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Document Object Identifier (DOI): 10.3386/w20512

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