Munich Personal RePEc Archive

Investment Timing and Vertical Relationships

Billette de Villemeur, Etienne and Ruble, Richard and Versaevel, Bruno (2013): Investment Timing and Vertical Relationships. Published in: International Journal of Industrial Organization , Vol. 33, (March 2014): pp. 110-123.

This is the latest version of this item.

[img]
Preview
PDF
MPRA_paper_47804.pdf

Download (584kB) | Preview

Abstract

We show that the standard analysis of vertical relationships transposes directly to investment dynamics. Thus, when a firm undertaking a project requires an outside supplier (e.g., an equipment manufacturer) to provide it with a discrete input to serve a growing but uncertain demand, and if the supplier has market power, investment occurs too late from an industry standpoint. The distortion in firm decisions is characterized by a Lerner-type index. Despite the underlying investment option, greater volatility can result in a lower value for both firms. We examine several contractual alternatives to induce efficient timing, a novel vertical restraint being for the upstream to sell a call option on the input. We also extend the model to allow for downstream duopoly. When downstream firms are engaged in a preemption race, the upstream firm sells the input to the first investor at a discount such that the race to preempt exactly offsets the vertical distortion, and this leader invests at the optimal time. These results are illustrated with a case study drawn from the pharmaceutical industry.

Available Versions of this Item

UB_LMU-Logo
MPRA is a RePEc service hosted by
the Munich University Library in Germany.