Does asymmetric information always help entry deterrence? Can it increase welfare?

• Published date: 01 July 2020
• DOI: http://doi.org/10.1111/jems.12350
• Date: 01 July 2020
• Author: Margarida Catalão‐Lopes,Cesaltina Pacheco Pires

J Econ Manage Strat. 2020;29:686–705.wileyonlinelibrary.com/journal/jems686

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© 2020 Wiley Periodicals LLC

Received: 29 May 2017

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Revised: 21 March 2020

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Accepted: 30 March 2020

DOI: 10.1111/jems.12350

ORIGINAL ARTICLE

Does asymmetric information always help entry

deterrence? Can it increase welfare?

Cesaltina Pacheco Pires

1

|Margarida Catalão‐Lopes

2

1

Departamento de Gestão, CEFAGE‐UE,

Universidade de Évora, Évora, Portugal

2

CEG‐IST, Instituto Superior Técnico,

Universidade de Lisboa, Lisbon, Portugal

Correspondence

Cesaltina Pacheco Pires, Departamento de

Gestão, CEFAGE‐UE, Universidade de

Évora, Largo dos Colegiais, No. 2, Évora

7000‐803, Portugal.

Email: cpires@uevora.pt

Funding information

Fundação para Ciência e Tecnologia,

Grant/Award Numbers: UID/ECO/04007,

UID/GES/00097

Abstract

This paper compares the scenarios of complete and incomplete information in

a general model where the incumbent can make a capital investment to deter

entry. We show that the informational structure can make an unexpected

difference in terms of entry deterrence and efficiency. Although asymmetric

information encourages entry deterrence behavior, in some cases it decreases

the probability of this behavior inducing no entry and thus promotes compe-

tition. In other cases, asymmetric information induces less entry but may lead

to higher welfare.

1|INTRODUCTION

Although widely explored in the literature both empirically and from a theoretical point of view, entry deterrence

behavior is commonly not given the deserved attention by antitrust practice when analyzing potentially anticompetitive

behaviors. In 2017–2018, the proposed acquisition of Media Capital, a large player in the Portuguese multimedia

market, by Altice, a firm with important participation in the telecommunications market, was not considered from an

entry threat perspective, but simply from the point of view of the impact upon existing rival firms.

The telecommunications authority assessed the impact of the acquisition on the electronic communications market

and concluded that it was liable to create significant impediments to effective competition in the various electronic

communications markets, preventing the access of rivals to critical assets and affecting the final consumer.

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The

potential impact on the other incumbents was detailed, but nothing was mentioned on the accrued possibility of

deterring the entry of new players. Actually, the effects on potential competition and entry decisions were unnoticed

throughout this extended investigation. Given that a spectrum auction is expected soon for the 5th generation mobile

communication system,

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with the possibility of new players trying to enter the market, analyzing possible entry

deterrent behaviors from incumbents seems necessary and timely. The current paper draws the attention to this

neglected part of the problem, focusing on the role of information.

The markets encompassed in this real case are examples of scope economies. Even though enlarging the portfolio of

products (bundling) or suppressing competition may also be acquisition motives, given the diversity of interrelated

services offered by the two players (audio visual contents, television, radios, web portals, fixed and mobile commu-

nications, among others) economies of scope can be obtained through news sources, human capital, advertising,

product cross‐selling or at the technological level, for instance, with synergies between the multiple divisions, thus

reducing unitary and marginal costs and making new entry less attractive.

As initially shown by Pires and Catalão‐Lopes (2013) in an incomplete information setup, in the presence of scope

economies expanding to a related market may be used to prevent competition from entrants. But is the success of the

entry deterrence strategy under economies of scope specific to incomplete information environments? Moreover,

should competition authorities promote information sharing about scope economies? In general, authorities can force

firms to reveal relevant information for market competition and entry, but should they do it?

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It is thus relevant to assess the impact of information asymmetry on the effectiveness of entry deterrent strategies. In

this paper, we provide a thorough comparison of the scenarios of complete and incomplete information to answer three

related questions. The first question is whether incomplete information encourages entry deterrence behavior. The

second question is whether there is more or less entry under incomplete information. The final question is whether

incomplete information helps entry deterrence, taking into account both whether incomplete information encourages

entry deterrence behavior and the effectiveness of this behavior in increasing the probability of no entry. This com-

parison is the main contribution of the current paper and allows to conclude that asymmetric information encourages

entry deterrence but that, in some cases, is detrimental to the success of entry deterrence behavior, as it decreases the

probability of inducing no entry.

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The adequacy of authorities promoting information spreading is worth questioning,

on the basis of a welfare comparison between the outcome of both scenarios, considering whether diversification does

or does not happen, and whether diversification does or does not prevent entry.

One can argue that dealing with asymmetry of information makes the task of antitrust authorities harder as it is

much easier to rely on observed measures of large capacity investments, for instance (a complete information scenario),

than to argue on the basis of beliefs (an incomplete information scenario). However, our analysis shows that incomplete

information may lead to outcomes with higher welfare than complete information and that there are cases where the

competition authorities should refrain from prohibiting entry deterrence strategies. Moreover, although full informa-

tion is commonly seen as more procompetitive than asymmetric information and authorities usually promote in-

formation sharing among competitors,

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this paper shows that, in an imperfect competition setup, more information

asymmetry may lead to more entry and thus more competition.

Besides these arguments, our paper may offer insights for empirical work testing the impact of asymmetric information

on entry deterrence and entry behavior, such as Seamans (2013) who investigates the prices of incumbent cable TV providers

in the presence of entry threats when some incumbents have proprietary access to a new technology and so entrants do not

know their costs. Evidence of entry deterrence behavior was found in industries identified as having scope economies, such

as health‐care (Dafny, 2005, on electrophysiological studies; Schmidt‐Dengler, 2006, on nuclear magnetic resonance imaging;

Ellison & Ellison, 2011, on pharmaceutical products), airlines (Sweeting, Roberts, & Gedge, 2020), and cable TV markets

(Seamans, 2013). The latter author shows evidence of limit pricing in the US cable TV industry. In the software industry, also

characterized by important economies of scope, evidence of entry deterrence based on limit pricing behavior has been found

for Microsoft on the combined price of Windows and Office (Hall, 2008). In Madeira island, Portugal, the laundry service is

an oligopoly with three important players, two of which operate solely in the tourism segment (hotels, restaurants, serviced

apartments), whilst the other also operates in the health segment (hospital, clinics, retirement residences), with clear scope

economies arising through fixed costs and that may facilitate entry deterrence strategies.

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Despite all these examples, the investment in economies of scope has been almost ignored by the entry deterrence

literature. The exception is the already mentioned work by Pires and Catalão‐Lopes (2013), who develop a linear

demand quantity competition model with incomplete information, where the entrant does not know the degree

of economies of scope of the incumbent and the incumbent uses the expansion to a related market to signal his degree

of economies of scope. We use the same basic idea that by diversifying to another market the incumbent benefits from

economies of scope, but there are two important differences between the current paper and Pires and Catalão‐Lopes

(2013). The first is that the assumptions in the current paper are completely general as concerns the strategic nature of

the variable employed, the demand functional form, the cost function, and the prior beliefs probability distribution.

Thus, our results have a much broader scope and general applicability. The second, and more important, is that we

introduce the complete information scenario (which the authorities usually seek) and compare the two informational

scenarios. This allows to draw conclusions as to which scenario is more procompetitive under which parameter

combinations. By performing welfare comparisons, we also provide new insights as to when the authorities should or

should not be concerned with the absence of complete information and promote, or not, information sharing.

From a theoretical perspective, there are two categories of entry deterrence models: (a) models based on capital

investments that have commitment value (pioneered by Spence, 1977 and Dixit, 1979,1980, and applied to investment in

learning by doing to deter entry by Fudenberg & Tirole, 1983 and Spence, 1981), generally assuming complete in-

formation, as the entrant observes the incumbent's investment, and (b) models based on the existence of asymmetric

information between the incumbent and the entrant (pioneered by Milgrom & Roberts, 1982, and extended in several

ways including the use of multiple signaling devices by Bagwell, 2007 or Pires & Jorge, 2012, or to repeated signaling

PIRES AND CATALÃO‐LOPES

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