Stefan Lutz

Quality leadership when regulatory standards are forthcoming

In many markets, governments set minimum quality standards while some sellers compete on the basis of quality by exceeding them. Such quality leadership strategies often win public acclaim, especially when they involve environmental attributes. Using a duopoly model of vertical product differentiation, we show that if the high-quality firm can commit to a quality level before regulations are promulgated, it induces the regulator to weaken standards, and welfare falls. Our results raise doubts about the social benefits of corporate self-regulation, and highlight the dangers of lengthy delays between legislative mandates for new regulations and their implementation. Copyright 2000 by Blackwell Publishing Ltd

Vertical product differentiation and entry deterrence

I study how a potential entrant influences quality in a model of vertical product differentiation with quality-dependent production costs. With identical costs, the incumbent will always deter entry if possible, i.e., if fixed costs are high. Quality will be set at a level lower than or equal to the optimal quality under either duopoly or monopoly. Results are completely different when the entrant has substantially lower costs. They are explained by the relative location of the entrants quality best response to the incumbents optimal quality choice in monopoly. This sheds new light on the influence of industrial policy on market conduct.

Risk premia in multi-national enterprises

The CAPM implies that investors require equity risk premia when choosing risky investments and therefore demand higher returns to equity invested if higher risk is present. This should apply to investments in independent enterprises and multi-national enterprises alike. This hypothesis is investigated by analyzing a panel of 407,000 European firms for the years 1985 to 2010. When income is set in relation to invested capital, risk measured by earnings volatility emerges as the most important stable determinant of income. Results indicate that both MNEs and independent firms regularly account for risk as a major determinant of income when pricing international goods and services. Hence international taxation rules for multi-national enterprises should account for risk premia in transfer prices and resulting profits.

Fiscal and monetary policy on the way to EMU

We present the simulations of fiscal adjustment policies to the Maastricht criteria in the European economies based on a rational-expectations model of the G7 economies. We find that an effort to achieve the fiscal criteria inflicts pronounced recessions on the European economies. Furthermore, the fiscal and the inflation criteria lack consistency. A return to fixed exchange rates in Europe worsens the results of fiscal retrenchment in Europe. All of this implies that a “hard” interpretation of the criteria is neither a desirable nor a credible strategy for EMU.

Preemption, Predation, and Minimum Quality Standards

We present a model of vertical product differentiation and exit where a domestic and a foreign firm face fixed setup costs and quality-dependent costs of production and compete in quality and price in the domestic market. Quality-dependent costs are quadratic in qualities, but independent of the quantities produced. The domestic government may impose a minimum quality standard binding for both foreign and domestic firms. In the presence of an initial cost advantage of the domestic firm, a sufficiently high minimum quality standard set by the domestic government will enable the domestic firm to induce exit of the foreign firm, i.e. to engage in predation. However, the same standard would lead to predation by the foreign firm, if the foreign firm had the initial cost advantage!

Risk as Determinant of Income and Cross-Border Pricing of Multi-National Enterprises

International taxation rules for multi- national enterprises (MNEs) prescribe that international prices for goods and services between different subsidiaries – and therefore incomes of these subsidiaries - must be comparable to those set between independent international firms for the purpose of taxation. These rules also prescribe that risk should be accounted for in pricing and income. Since current practice of price comparisons does not yet fully allow accounting for risk, prices and in turn earnings and taxation may be distorted. We analyze a panel of about 160,000 European manufacturing, wholesale and retail trade firms for the years 1992 to 2007 in order to establish to what extent earnings do take risk into account. Risk measured by earnings volatility emerges as one major determinant of income. When earnings are set in relation to invested capital, risk emerges as the only stable determinant of income. Results indicate that both MNEs and independent firms regularly account for risk as a major determinant of income when pricing international goods and services.

International Strategic Choice of Minimum Quality Standards and Welfare

We study the influence of minimum quality standards in a two-region partial-equilibrium model of vertical product differentiation and trade. Three alternative standard setting arrangements are considered: Full Harmonization, National Treatment and Mutual Recognition. The analysis integrates the choice of a particular standard setting alternative by governments into the model. We provide a set of sufficient conditions for which Mutual Recognition emerges as one regulatory alternative that always improves welfare in both regions when compared to the case without regulation. We show that Mutual Recognition, being the default procedure if governments do not reach a unanimous decision, is the only possible equilibrium of the game.

Mixed Oligopoly, Vertical Product Differentiation and Fixed Quality-Dependent Costs

A private and a public firm face fixed quality-dependent costs of production and compete first in quality and then either in prices or in quantities. In the long run the public firm targets welfare maximization whereas the private firm maximizes profits. In the short run both firms compete in prices or quantities to maximize profits. Mixed competition is always socially desirable compared to a private duopoly regardless of the type of competition in the short run and the equilibrium quality ranking. In addition, mixed competition seems to be a more efficient regulatory instrument than the adoption of a minimum quality standard.

A Multi-Product Framework Generating Waves of Mergers and Divestitures

Recent waves of corporate mergers followed by divestitures have sparked new interest in economic analyses of these issues. We take the merger paradox from the standard oligopoly literature as a starting point and show that in the absence of any cost-synergies of merger activities, firms do have an incentive to divest further instead of joining mergers. We then analyze conditions where mergers may emerge endogenously as a result of a market game. Due to the nature of the interaction of market-share and market-concentration effects in Cournot oligopolies, a stable internal equilibrium where mergers arise endogenously and simultaneously requires both cost synergies and cost dissynergies. Endogenous merger size is then a function of market parameters as well as cost synergy parameters. Hence anticipated changes in market size or cost synergies attainable through mergers lead to reconfigurations of merger sizes. If ex-ante expectations about merger-promoting changes are not fully realized ex-post, merger waves will be followed by divestiture waves. Firm valuation - based on ex-ante expectation - may increase while actual profits and efficiency of the merged entity - according to the ex-post realization - may fall.

Financing and Performance of Female-Owned Firms in Middle Eastern and African Economies

Empirical evidence suggests that lack of access to financing is a major constraint to performance by female-owned firms in most countries. Firm performance, financing structure, and constraints have been well explored for firms in developed economies but this is not the case for firms in developing economies, especially in Africa and the Middle-East. Largely due to lack of data availability, existing literature on African firms has presented some survey-based evidence on firm performance and financing structures while detailed financial evidence is lacking. This paper aims at filling this research gap. We identify female-owned firms and examine the impact of ownership structure on financing and firm performance. We use cross-sectional financial data covering 25,500 companies in the Middle East and Africa for the years 2006 to 2014. Our results reveal a clear, but perhaps surprising, gender-specific pattern.