Monopoly Power and the Firm's Valuation: A Dynamic Analysis of Short Versus Long-Term Policies

32 Pages Posted: 16 Sep 2000

See all articles by Anna Pavlova

Anna Pavlova

London Business School; Centre for Economic Policy Research (CEPR)

Suleyman Basak

London Business School; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: January 2004

Abstract

Recent anti-trust cases exacerbated the concerns of investors regarding the effects of a firm's monopoly power on its production choice, shareholder value, and the overall economy. We address this issue within a dynamic equilibrium model featuring a large monopolistic firm whose actions not only affect the price of its output, but also effectively influence the valuation of its stock. The latter renders time inconsistency to the firm's dynamic production choice. When the firm is required to pre-commit to its strategy, the ensuing equilibrium is largely in line with the predictions of the textbook monopoly model. When the firm behaves in a time-consistent manner, however, the predictions are strikingly at odds. The trade-off between current profits and the valuation of future profits induces the firm to increase production beyond the competitive benchmark and cut prices. This policy may result in destroying shareholder value, and does indeed fully wipe out the firm's profit in the limit of the decision-making interval shrinking to zero, in line with the Coase conjecture.

Keywords: Monopoly; Asset Pricing Theory; General Equilibrium; Short-Sighted; Time-Consistency; Coase Conjecture

JEL Classification: D42, D51, D92, E20, G12

Suggested Citation

Pavlova, Anna and Basak, Suleyman, Monopoly Power and the Firm's Valuation: A Dynamic Analysis of Short Versus Long-Term Policies (January 2004). MIT Sloan Working Paper No. 4234-01; EFA 2001 Barcelona Meetings; AFA 2001 New Orleans Meetings. Available at SSRN: https://ssrn.com/abstract=242364 or http://dx.doi.org/10.2139/ssrn.242364

Anna Pavlova

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 20 7000 8218 (Phone)

HOME PAGE: http://faculty.london.edu/apavlova

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Suleyman Basak (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
44 (0)20 7000 8256 (Phone)
44 (0)20 7000 8201 (Fax)

HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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