Regulatory Barriers and Entry into a New Competitive Industry

• Author: John Bennett,Saul Estrin
• Date: 01 November 2013
• Published date: 01 November 2013
• DOI: http://doi.org/10.1111/rode.12059

Regulatory Barriers and Entry into a New

Competitive Industry

John Bennett and Saul Estrin*

Abstract

We model the effects of license fees and bureaucratic delay on firm entry into a new competitive industry,

whose profitability is initially unknown. A license fee alone reduces the number of first movers and the

steady-state number of firms. The combination of license fee and delay may cause some entrepreneurs to

purchase licenses speculatively, only using them to enter production later if profitability is revealed to be

sufficiently favourable. Alternatively, some entrepreneurs may wait, possibly buying a license only after

profitability is revealed; but it is never found that some entrepreneurs adopt one of these strategies and

some the other.

1. Introduction

Entry processes in advanced economies have commonly been modeled in terms of the

characteristics of firms, such as plant size, age, and ownership type (Dunne et al.,

1989). In developing economies, however, institutional weaknesses also have to be

taken into account (Tybout, 2000), and entry rates have been found to be lower where

governments impose more onerous regulations on entry (Klapper et al., 2006). In this

paper we analyze how entry by new firms in a developing economy may be affected

by two forms of regulatory barrier: the imposition of a license fee for entry and

bureaucratic delay in issuing the license once the fee has been paid. As would be

expected intuitively, both of these forms of barrier are found generally to have an

adverse impact on entry, but our focus is on how the timing of entry is affected. In

particular, we show how bureaucratic delays may lead to speculative behavior among

potential entrants, with more entry licenses being purchased than may then be used.

An implication is that data on new firm registration in economies where entry barriers

are high may overstate reality.

To analyze these issues we formulate a model of the entry of firms into a newly

established market. It is assumed that, initially, there is uncertainty about the profit-

ability of the industry; but, with a lag, entry by first movers reveals this profitability to

all potential entrants. In the first version of the model each entrepreneur must decide

whether to be a first mover, sinking costs before the profitability of the industry is

known, or to wait, entering late if revealed profitability justifies the sinking of costs.

* Estrin: Management Department, London School of Economics, Houghton Street, London WC2A2AE,

UK. Tel: +44-(0)20-7955-6629; Email: s.estrin@lse.ac.uk. Bennett: Department of Economics and CEDI,

Brunel University, Uxbridge, Middlesex, UB8 3PH, UK. We thank the Department for International

Development for supporting this research under DFID/ESCOR project number R7844. Earlier versions of

the paper were presented at the EBRD, London, February, 2005; the Latin American and Caribbean Eco-

nomic Association Annual Conference, Paris, October, 2005; and at the ASSA meeting, Boston, January,

2006. We are grateful to the participants, and particular to Dan Berkowitz and Hadi Esfahani, for their

comments. We also gratefully acknowledge the insightful reports of two anonymous referees, and com-

ments and suggestions from Robin Burgess, Ravi Kanbur, Daniel Kaufmann, Mark Roberts, Stefano

Scarpetta and Kathy Terrell. The usual disclaimer applies.

Review of Development Economics, 17(4), 685–698, 2013

DOI:10.1111/rode.12059

© 2013 John Wiley & Sons Ltd