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Title: Optimal Regulation in the Presence of Reputation Concerns

Author(s): Andrew Atkeson, Christian Hellwig and Guillermo Ordo�ez

Publication Date: July 2014

Keyword(s): entry regulation, firm dynamics, quality investments and reputation concerns

Programme Area(s): Industrial Organization

Abstract: In all markets, firms go through a process of creative destruction: entry, random growth and exit. In many of these markets there are also regulations that restrict entry, possibly distorting this process. We study the public interest rationale for entry taxes in a general equilibrium model with free entry and exit of firms in which firm dynamics are driven by reputation concerns. In our model firms can produce high-quality output by making a costly but efficient initial unobservable investment. If buyers never learn about this investment, an extreme `"lemons problem" develops, no firm invests, and the market shuts down. Learning introduces reputation incentives such that a fraction of entrants do invest. We show that, if the market operates with spot prices, entry taxes always enhance the role of reputation to induce investment, improving welfare despite the impact of these taxes on equilibrium prices and total production.

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Bibliographic Reference

Atkeson, A, Hellwig, C and Ordo�ez, G. 2014. 'Optimal Regulation in the Presence of Reputation Concerns'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10080