Entry Deterrence under Agency Constraints

Abstract

We study models of signaling and entry deterrence when the incumbent firm is subject to agency restraints and the principal does not have the relevant information to signal to the potential_x000D_ entrant. The informational implications of the dynamic agency relationship are fully identified. A characterization of optimal contracts is given for both the case of deterministic markets as well as stochastic markets. Moreover, the differences between whether incentive contracts are observable or hidden are presented. We find that one would expect that the study of agency and entry is relevant in many markets, as agency makes entry more lucrative and principals may have reasons to invite entry to alleviate agency costs. We also propose empirically testable hypotheses that are based on the insights of this paper. This study suggests that entry deterrence is more likely to occur in less volatile markets. Also, entry deterrence is found to be more effective when incentives can credibly be made public.