Annals of Operations Research

, Volume 114, Issue 1, pp 203–227

Strategic Experimentation in Financial Intermediation with Threat of Entry

  • Neelam Jain
  • Thomas D. Jeitschko
  • Leonard J. Mirman
Article

DOI: 10.1023/A:1021070405196

Cite this article as:
Jain, N., Jeitschko, T.D. & Mirman, L.J. Annals of Operations Research (2002) 114: 203. doi:10.1023/A:1021070405196

Abstract

We study how the threat of entry affects financial contracting between an incumbent firm and a bank, in a stochastic and dynamic environment. Contracts are short term and public. We determine the effects of the first period financial contract on the first period outputs in face of the threat of entry. Specifically, it is shown that the distance between first period outputs is increased due to potential entry. This is due to two underlying effects: first, the threat of entry reduces the signal dampening effect and thus the surplus left to the low cost incumbent is reduced. Second, learning is more valuable as it decreases the probability of entry. Indeed, experimentation takes on a strategic form, since the bank must take into account the impact of the possible game on its expected profits. This work integrates the agency problem between a firm and its financial intermediary with the issue of entry-deterrence under uncertainty.

experimentationstrategic experimentationsignal dampeningfinancial intermediationlimit pricingentry deterrence

Copyright information

© Kluwer Academic Publishers 2002

Authors and Affiliations

  • Neelam Jain
    • 1
  • Thomas D. Jeitschko
    • 2
  • Leonard J. Mirman
    • 3
  1. 1.Graduate School of ManagementRice UniversityHoustonUSA
  2. 2.Department of EconomicsMichigan State UniversityEast LansingUSA
  3. 3.Department of EconomicsUniversity of VirginiaCharlottesvilleUSA