Excess Capacity and Entry: Some Empirical Evidence

Abstract

RECENT articles by Spence [I977], Dixit [I979], and Schmalensee [I98I] have elaborated on Wenders' [I97I1 proposition that excess capacity can act as a barrier to entry. The intent of all of these treatments is to suggest that firms may rationally invest in excess capacity with the expectation that excess capacity will be seen by potential entrants either as a signal of aggressive intent' or as a credible threat.2 When excess capacity does not lead to creation of a credible threat, it may still act as a barrier to entry by shifting the risk-return perceptions of potential entrants enough to divert the potential entrants' investments into other industries. 3 Alternatively, investment in excess capacity by incumbent firms may reduce the prospects of an active market for the used equipment of a defunct entrant and thereby help to convert fixed costs into sunk costs, consequently raising entry barriers.4 This paper represents an exploratory effort to investigate empirically the prevalence and efficiency of excess capacity in deterring entry. First, a simple and traditional model of entry is presented. This is followed by the description of the data used to explore the excess capacity-investment concept. A combined results and comments section follows the description of the data.