Academic journal article Economic Inquiry

Information Value under Demand Uncertainty and Endogenous Market Leadership

Academic journal article Economic Inquiry

Information Value under Demand Uncertainty and Endogenous Market Leadership

Article excerpt

I. INTRODUCTION

Two critical ways that a firm may have an advantage over competitors are superior information (regarding uncertain demand, for example), and the strategic value of market leadership. We study the connection between these by asking whether an information advantage may enable a firm to achieve leadership in a market. Put differently, if a firm that is known to be better informed than competitors leads a market, will its competitors choose to follow? How then does this impact the value of information?

Market structure, and market leadership in particular, has been shown to play an important role in determining the value of information in a market and incentives for acquiring and sharing information. (1) Raju and Roy (2000) studied the effect of market structure on the value of information and found that knowledge of market demand has greater value in Stackelberg competition with one firm in a position of strategic market leadership than when the structure is Bertrand-Nash competition. In a supply chain setting with two competing downstream firms and one supplier, Anand and Goyal (2009) considered the incentive for one of the downstream firms that acts as a Stackelberg leader to acquire information regarding the realization of uncertain market demand. A common feature of these models is that they treat the market structure as exogenous when studying the role of information. Conversely, we develop a model that shows how an information advantage of early knowledge of realized demand can give rise to Stackelberg market leadership. For the case of duopoly we can then address the firms' willingness to pay for such information in a setting where both information and market structure are endogenous.

Our model builds on several papers (discussed below) which have modeled the strategic choice of the timing of actions in games. Most of this literature has been in the industrial organization context where quantity competition between firms is the classic example of first-mover advantage (the Stackelberg model), which invites the question of how leadership is achieved. However, timing games with endogenous leadership have been described in other contexts as well, including public goods provision (Kempf and RotaGraziosi 2010a) and tax competition (Kempf and Rota-Graziosi 2010b), in which the players are governments. The impact of information on the timing of the quantity competition game between firms, and the resulting value of information and market structure, is closely analogous to such strategic environments. Our model can therefore be more broadly understood as identifying conditions for which an information advantage may impart leadership, and the consequent value of information, in games that exhibit first-mover advantage.

The role of information asymmetry in determining the timing of actions in markets has been analyzed in prior work, but a key assumption has been that the information known by an informed firm (the realization of an uncertain market demand) is never directly revealed to uninformed firms regardless of the timing of their actions. Consequently, a signaling game arises with uninformed firms possibly able to infer some information from the actions of the informed firm if they act as a follower in the market. This signaling dynamic is interesting but generates a complex strategic environment which limits the analysis and does not lead unambiguously to leadership by an informed firm in equilibrium. The value of information is highly dependent on this context. For example, in the study of Daughety and Reinganum (1994) it is an equilibrium for more than one firm to obtain information only if it is free. We assume instead that any information advantage is perishable. That is, a firm may "get a jump" on competitors, becoming informed about realized demand earlier than others and thus have the possibility of acting in the market based on this information at a time when other firms can act based only on expectations. …

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