Informational rents and the excessive entry theorem: The case of hidden action*

Abstract

AbstractEntry in a homogeneous Cournot‐oligopoly is excessive if there is business‐stealing. These findings assume that production costs reduce profits and welfare equally. If firms pay informational rents due to frictions in the employer–employee relationship, production costs partly reflect transfers, which do not alter welfare directly. We investigate the excessive entry theorem in the presence of rents. We find that informational rents can invalidate the theorem. Rents reduce profits and deter entry into the market equilibrium, while the socially optimal number of firms is not affected directly. The rent effect becomes stronger the lower the number of firms and can overcompensate the business‐stealing externality. As an example, we model a hidden action problem in which employees have an informational advantage after signing the contract with the firm. Insufficient entry occurs if entry costs are sufficiently high because they lower the number of firms and raise informational rents.