Leaders, Followers, and Risk Dynamics in Industry Equilibrium

Murray Carlson, Engelbert Dockner, Adlai Fisher and Ron Giammarino

Journal of Financial and Quantitative Analysis, 2014, vol. 49, issue 2, 321-349

Abstract: We study the distinct impacts of own and rival actions on risk and return when firms strategically compete in the product market. Contrary to simple intuition, a competitor’s options to adjust capacity reduce own-firm risk. For example, if a rival possesses a growth option, an increase in industry demand directly enhances profits but also encourages value-reducing competitor expansion. The rival option thus acts as a natural hedge. Within the industry, we obtain endogenous differences in expected returns. In a leader-follower equilibrium, own-firm and competitor risks and required returns move together through contractions and oppositely during expansions, providing testable new predictions.

Date: 2014
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