A Positive Theory of Regulatory Endogenous Sunk Costs

30 Pages Posted: 13 Aug 2012 Last revised: 27 Nov 2014

Van H. Pham

Baylor University - Department of Economics

David D. VanHoose

Baylor University - Department of Economics

Date Written: November 3, 2014

Abstract

We propose a theory of 'regulatory endogenous sunk costs' (RESC), in which a captured regulator raises minimum quality standards when market size increases in order to protect incumbent firms. Our RESC theory's predictions that market size is unrelated to industry concentration and positively related to product quality are observationally equivalent to those of Sutton's theory of 'natural endogenous sunk costs' (NESC), in which incumbents increase quality investments to compete for a share of a growing market. The NESC theory suggests that, with higher entry costs, incumbents jockey for increased market shares by increasing quality investments. The RESC theory, however, predicts that product quality should be lower with higher entry costs. Entry costs and minimum quality standards each provide incumbents with protection from profit erosions that entry otherwise would produce. A key implication of our analysis is the possibility that some industries might be misclassified as natural oligopolies. We provide a few examples of candidate RESC industries.

Keywords: Regulatory compliance costs, endogenous sunk costs

JEL Classification: L13, L51

Suggested Citation

Pham, Van H. and VanHoose, David D., A Positive Theory of Regulatory Endogenous Sunk Costs (November 3, 2014). Available at SSRN: https://ssrn.com/abstract=2128610 or http://dx.doi.org/10.2139/ssrn.2128610

Van H. Pham (Contact Author)

Baylor University - Department of Economics ( email )

One Bear Place #98003
Waco, TX 76798
United States
(254) 710-3521 (Phone)
(254) 710-6142 (Fax)

HOME PAGE: http://www.baylor.edu/van_pham

David D. VanHoose

Baylor University - Department of Economics ( email )

P.O. Box 98003
Waco, TX 76798-8003
United States

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