Competition and Cost Accounting: Adapting to Changing Markets

Abstract

This paper experimentally investigates the effect of changes in product-market competition on changes in decisions about the accuracy of product costing. In repeated independent trials, subjects decide on the quantity of data to collect at a pre-set price per datum to support more accurate product-cost estimates. In the increasing-competition condition, subjects begin as monopolists and face first one new entrant and then two additional entrants in the market. In the decreasing-competition condition, subjects begin in a four-firm market from which two firms and then the third firm exit. Subjects collect the most data to support product-cost estimates in monopoly, least in duopoly, and an intermediate amount in the four-firm market, consistent with the pattern of optimal cost-data collection in Hansen's (1998) model. The process of convergence to the optimum differs significantly across market types and market histories, however. Subjects who begin with four-firm competition and end in monopoly make more nearly optimal decisions than those who begin in monopoly and end in the four-firm market. The lowest levels of decision performance occur when ex-monopolists face their first competitor: they overreact to this first encounter with competition and overspend on cost data.

JEL Classification: M40, M46