Strengthening a Weak Rival for a Fight
20 Pages Posted: 14 Sep 2014 Last revised: 15 Oct 2018
Date Written: October 15, 2018
We provide a new model wherein firms of different productivities survive in an industry despite the threat of entry by high productivity firms. We demonstrate that an effi- cient incumbent has a unilateral incentive to establish a relational contract, softening price competition to strengthen its inefficient rival in a war of attrition that emerges post-entry, and raising the price of the inefficient firm in the acquisition market. We show that this equilibrium gives rise to persistent performance differences, market com- pression, and stability in the identity of firms in the market. Moreover, the relational contracting equilibrium is facilitated by strong anti-trust laws.
Keywords: persistent performance differences, potential entry, war of attrition, spatial competition
JEL Classification: L22, L11
Suggested Citation: Suggested Citation