Sunk Costs and Risk-Based Barriers to Entry
In merger analysis and other antitrust settings, risk is often cited as a potential barrier to entry. But there is little consensus as to the kinds of risk that matter - systematic versus non-systematic and industry-wide versus firm-specific - and the mechanisms through which they affect entry. I show how and to what extent different kinds of risk magnify the deterrent effect of exogenous sunk costs of entry, and thereby affect industry dynamics, concentration, and equilibrium market prices. To do this, I develop a measure of the "full," i.e., risk-adjusted, sunk cost of entry. I show that for reasonable parameter values, the full sunk cost is far larger than the direct measure of sunk cost typically used to analyze markets.
My thanks to Dennis Carlton,Wouter Dessein, Joe Farrell, Michael Riordan, Manuel Trajtenberg, Yoram Weiss, and seminar participants at Brandeis, Columbia, and Tel Aviv Universities for helpful comments and suggestions, and to Eric Wang for superb research assistance.
The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.