Excess Capacity as an Incentive Device

Rudolf Kerschbamer and Yanni Tournas

No 1625, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper studies the factors determining plant size and interplant output allocation within the boundaries of a multiplant firm under conditions of demand uncertainty. It shows that asymmetric information between headquarters and individual plants is one factor determining plant size and output allocation: since the existence of excess capacity creates ‘high powered’ incentives for individual plants, capacity levels in a second-best setting exceed the corresponding benchmark in a first-best world if capacity prices are low. The presence of ‘agency costs’ in the case of fully-utilized capacity reverses this result for high-capacity prices. Also, in a recession output is not necessarily assigned to the plant with the lowest production costs.

Keywords: Asymmetric Information; Excess Capacity; Multiplant Firm (search for similar items in EconPapers)
JEL-codes: D82 L22 L23 (search for similar items in EconPapers)
Date: 1997-05
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Working Paper: Excess Capacity as an Incentive Device (1997)
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