Hostname: page-component-848d4c4894-sjtt6 Total loading time: 0 Render date: 2024-06-24T08:32:50.796Z Has data issue: false hasContentIssue false
  • English
  • Français

Leaders, Followers, and Risk Dynamics in Industry Equilibrium

Published online by Cambridge University Press:  04 June 2014

Murray Carlson ,
Engelbert J. Dockner ,
Adlai Fisher  and
Ron Giammarino
Murray Carlson
Affiliation:
murray.carlson@sauder.ubc.ca, Sauder School of Business, University of British Columbia, 2053 Main Mall, Vancouver, BC V6T 1Z2, Canada
Engelbert J. Dockner
Affiliation:
engelbert.dockner@wu.ac.at, Wirtschaftsuniversität Wien, Vienna University of Economics and Business, Heiligenstaedter Strasse 46-48, Vienna A-1190, Austria
Adlai Fisher
Affiliation:
adlai.fisher@sauder.ubc.ca, Sauder School of Business, University of British Columbia, 2053 Main Mall, Vancouver, BC V6T 1Z2, Canada
Ron Giammarino
Affiliation:
ron.giammarino@sauder.ubc.ca, Sauder School of Business, University of British Columbia, 2053 Main Mall, Vancouver, BC V6T 1Z2, Canada
Get access Rights & Permissions [Opens in a new window]

Abstract

We study the distinct impacts of own and rival actions on risk and return when firms strategically compete in the product market. Contrary to simple intuition, a competitor’s options to adjust capacity reduce own-firm risk. For example, if a rival possesses a growth option, an increase in industry demand directly enhances profits but also encourages value-reducing competitor expansion. The rival option thus acts as a natural hedge. Within the industry, we obtain endogenous differences in expected returns. In a leader-follower equilibrium, own-firm and competitor risks and required returns move together through contractions and oppositely during expansions, providing testable new predictions.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 49 , Issue 2 , April 2014 , pp. 321 - 349
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2014 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Aguerrevere, F. “Equilibrium Investment Strategies and Output Price Behavior: A Real Option Approach.” Review of Financial Studies, 16 (2003), 1239–1272.CrossRefGoogle Scholar
Aguerrevere, F. “Real Options, Product Market Competition, and Asset Returns.” Journal of Finance, 64 (2009), 957–983.CrossRefGoogle Scholar
Ali, A.; Klasa, S.; and Yeung, E.. “The Limitations of Industry Concentration Measures Constructed with Compustat Data: Implications for Finance Research.” Review of Financial Studies, 22 (2009), 3839–3871.CrossRefGoogle Scholar
Back, K., and Paulson, D.. “Open-Loop Equilibria and Perfect Competition in Option Exercise Games.” Review of Financial Studies, 22 (2009), 4531–4552.Google Scholar
Bena, J., and Garlappi, L.. “Strategic Investments, Technological Uncertainty, and Expected Return Externalities.” Working Paper, University of British Columbia (2012).Google Scholar
Berk, J.; Green, R.; and Naik, V.. “Optimal Investment, Growth Options, and Asset Returns.” Journal of Finance, 54 (1999), 1553–1607.Google Scholar
Berk, J.; Green, R.; and Naik, V.. “Valuation and Return Dynamics of New Ventures.” Review of Financial Studies, 17 (2004), 1–35.CrossRefGoogle Scholar
Boyer, M.; Lasserre, P.; Mariotti, T.; and Moreaux, M.. “Real Options, Preemption, and the Dynamics of Industry Investments.” Working Paper, University of Montreal (2004).Google Scholar
Brealey, R., and Myers, S.. Principles of Corporate Finance. Boston: McGraw Hill (2001).Google Scholar
Brennan, M., and Schwartz, E.. “Evaluating Natural Resource Investments.” Journal of Business, 58 (1985), 135–157.Google Scholar
Bustamante, M. “Strategic Investment, Industry Concentration, and the Cross-Section of Returns.” Working Paper, London School of Economics (2011).Google Scholar
Carlson, M.; Fisher, A.; and Giammarino, R.. “Corporate Investment and Asset Price Dynamics: Implications for the Cross-Section of Returns.” Journal of Finance, 59 (2004), 2577–2603.Google Scholar
Carlson, M.; Fisher, A.; and Giammarino, R.. “Corporate Investment and Asset Price Dynamics: Implications for SEO Event Studies and Long-Run Performance.” Journal of Finance, 61 (2006), 1009–1034.Google Scholar
Carlson, M.; Fisher, A.; and Giammarino, R.. “SEO Risk Dynamics.” Review of Financial Studies, 23 (2010), 4026–4077.Google Scholar
Cooper, I. “Asset Price Implications of Nonconvex Adjustment Costs and Irreversibility of Investment.” Journal of Finance, 61 (2006), 139–170.Google Scholar
Cooper, R., and Haltiwanger, J.. “On the Nature of Capital Adjustment Costs.” Review of Economic Studies, 73 (2006), 611–633.Google Scholar
Dixit, A. The Art of Smooth Pasting: Fundamentals of Pure and Applied Economics, Vol. 55. London and New York: Routledge (1993).Google Scholar
Dixit, A., and Pindyck, R.. Investment Under Uncertainty. Princeton: Princeton University Press (1994).CrossRefGoogle Scholar
Dockner, E.; Jørgensen, S.; Long, N. V.; and Sorger, G.. Differential Games in Economics and Management Science. Cambridge: Cambridge University Press (2000).Google Scholar
Fudenberg, D., and Tirole, J.. “Preemption and Rent Equalization in the Adoption of New Technology.” Review of Economic Studies, 52 (1985), 383–401.Google Scholar
Fudenberg, D., and Tirole, J.. Game Theory. Cambridge: MIT Press (1991).Google Scholar
Garlappi, L. “Risk Premia and Preemption in R&D Ventures.” Journal of Financial and Quantitative Analysis, 39 (2004), 843–872.Google Scholar
Gomes, J.; Kogan, L.; and Zhang, L.. “Equilibrium Cross-Section of Returns.” Journal of Political Economy, 111 (2003), 693–732.Google Scholar
Grenadier, S. “The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets.” Journal of Finance, 51 (1996), 1653–1679.Google Scholar
Grenadier, S. “Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms.” Review of Financial Studies, 15 (2002), 691–721.Google Scholar
Hackbarth, D., and Morellec, E.. “Stock Returns in Mergers and Acquisitions.” Journal of Finance, 63 (2008), 1213–1252.Google Scholar
Hicks, J. R. “Annual Survey of Economic Theory: The Theory of Monopoly.” Econometrica, 3 (1935), 1–20.Google Scholar
Hou, K., and Robinson, D.. “Industry Concentration and Average Stock Returns.” Journal of Finance, 61 (2006), 1927–1956.CrossRefGoogle Scholar
Huisman, K., and Kort, P.. “Effects of Strategic Interaction on the Option Value of Waiting.” Working Paper, Tilburg University (1999).Google Scholar
Irvine, P. J., and Pontiff, J.. “Idiosyncratic Return Volatility, Cash Flows, and Product Market Competition.” Review of Financial Studies, 22 (2009), 1149–1177.Google Scholar
Johnson, T. “Rational Momentum Effects.” Journal of Finance, 57 (2002), 585–608.Google Scholar
Kogan, L. “Asset Prices and Real Investment.” Journal of Financial Economics, 73 (2004), 411–431.Google Scholar
Kuehn, L. “Asset Pricing with Real Investment Commitment.” Working Paper, Carnegie Mellon University (2008).CrossRefGoogle Scholar
Lambrecht, B., and Perraudin, W.. “Real Options and Preemption Under Incomplete Information.” Journal of Economic Dynamics and Control, 27 (2003), 619–643.Google Scholar
Mason, R., and Weeds, H.. “Investment, Uncertainty and Pre-Emption.” International Journal of Industrial Organization, 28 (2010), 278–287.Google Scholar
McDonald, R., and Siegel, D.. “Investment and the Valuation of Firms When There Is an Option to Shut Down.” International Economic Review, 26 (1985), 331–349.Google Scholar
McDonald, R., and Siegel, D.. “The Value of Waiting to Invest.” Quarterly Journal of Economics, 101 (1986), 707–727.Google Scholar
Murto, P. “Exit in Duopoly Under Uncertainty.” Rand Journal of Economics, 35 (2004), 111–127.Google Scholar
Novy-Marx, R. “Competition, Productivity, and the Cross-Section of Expected Returns.” Working Paper, University of Chicago (2008).Google Scholar
Pastor, L., and Veronesi, P.. “Technological Revolutions and Stock Prices.” American Economic Review, 99 (2009), 1451–1483.Google Scholar
Pawlina, G., and Kort, P.. “Real Options in an Asymmetric Duopoly: Who Benefits from Your Competitive Disadvantage?” Journal of Economics and Management Strategy, 15 (2006), 1–35.Google Scholar
Peress, J. “Product Market Competition, Insider Trading, and Stock Market Efficiency.” Journal of Finance, 65 (2010), 1–43.CrossRefGoogle Scholar
Reynolds, S. S. “Capacity Investment, Preemption and Commitment in an Infinite Horizon Model.” International Economic Review, 28 (1987), 69–88.CrossRefGoogle Scholar
Ross, S.; Westerfield, J.; and Jaffe, J.. Corporate Finance. Boston: Irwin (1996).Google Scholar
Sagi, J., and Seasholes, M.. “Firm-Specific Attributes and the Cross-Section of Momentum.” Journal of Financial Economics, 84 (2007), 389–434.Google Scholar
Smets, R. “Exporting vs. FDI: The Effect of Uncertainty.” Working Paper, Yale University (1991).Google Scholar
Stokey, N. The Economics of Inaction. Princeton: Princeton University Press (2009).Google Scholar
Thijssen, J.; Huisman, K.; and Kort, P.. “Symmetric Equilibrium Strategies in Game Theoretic Real Option Models.” Journal of Mathematical Economics, 48 (2012), 219–225.Google Scholar
Zhang, L. “The Value Premium.” Journal of Finance, 60 (2005), 67–103.Google Scholar