DP1625 Excess Capacity as an Incentive Device

Author(s):	Rudolf Kerschbamer, Yanni Tournas
Publication Date:	May 1997
Keyword(s):	Asymmetric Information, Excess Capacity, Multiplant Firm
JEL(s):	D82, L22, L23
Programme Areas:	Industrial Organization
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=1625

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.