Strategic Investment under Uncertainty with First- and Second-mover Advantages

Abstract

We analyze firm entry in a duopoly real-option game. The interaction between first- and second-mover advantages gives rise to a unique Markov subgame-perfect symmetric equilibrium, featuring state-contingent pure and mixed strategies in multiple endogenously-determined regions. In addition to the standard option-value-of-waiting region, a second waiting region arises because of the second-mover advantage. For sufficiently high market demand, waiting preserves the second-mover advantage but forgoes profits. Two disconnected mixed-strategy regions where firms enter probabilistically surface. In one such region, Leader earns monopoly rents while Follower optimally waits. Finally, when the first-mover advantage dominates the second-mover advantage, firms
enter using pure strategies.

Keywords: real option games, mixed strategies, probabilistic entry, wars of attrition

JEL Classification: E22, G13, G31, L13