Highlights
- Firms tend to voluntarily disclose their endogenous cost information across different market structures, with disclosure under Bertrand competition leading to less investment but higher profits. Under Cournot competition, this results in greater investment but lower profits.
- Regulation efforts, such as increasing the costs of disclosure, should consider market type, as such measures may either promote competition and benefit consumers in Cournot markets or hinder competition in Bertrand markets.
- Regardless of the competition type, firms are likely to disclose cost information voluntarily, which diminishes the impact of disclosure mandates, and the strategic role of such disclosures varies depending on whether firms’ production strategies are complements or substitutes.
The question of whether and how firms disclose their private information to competitors is a significant and well-researched topic in economics. Classical literature on firms’ information sharing under oligopoly settings indicates that the decision to disclose information depends on the type of competition, known as either Bertrand or Cournot competition, and the nature of the private information, such as demand or cost data.
Specifically, firms tend to withhold information in settings of Cournot/demand and Bertrand/cost but share it in Cournot/cost and Bertrand/demand. These results are based on how information sharing, which increases the accuracy of rival signals and the correlation of firms’ signals, influences expected profits. For example, when a firm observes a low signal for its unit cost and reveals it to a rival, the firm increases output under Cournot competition, while the rival decreases output, making sharing a dominant strategy. Conversely, under Bertrand competition, both firms tend to undercut prices, which makes concealing information the preferred strategy.
Despite evidence that costs are determined endogenously through investments in cost-cutting innovations, it remains unclear how these activities influence firms’ incentives to disclose their costs.
A common assumption in these models is that demand or cost information is drawn from an exogenous probability distribution. The researchers note, however, that a significant proportion of costs are often specific to individual firms and determined endogenously by each firm’s decisions. Many firms also adopt automation to reduce labour costs, and recent advances in generative artificial intelligence, such as ChatGPT, provide additional tools for cost savings. Despite evidence that costs are determined endogenously through investments in cost-cutting innovations, it remains unclear how these activities influence firms’ incentives to disclose their costs.
The researchers considered a noncooperative game involving duopoly firms with private information, engaged in either Cournot or Bertrand competition. These firms first decide whether to disclose their cost information, then determine quantities or prices in the market. The key departure from what is in the literature is the recognition that firms’ costs are endogenously determined by their investment choices. The study finds that disclosure can be sustained in equilibrium even under Bertrand competition, which contrasts with the classic view that firms tend to conceal private costs in duopoly settings with exogenous costs.
When investments endogenously determine costs, firms are more inclined to disclose cost information in Bertrand competition to avoid “overinvestment” in cost reduction and to coordinate their actions for mutual benefit. In this context, disclosure lets firms signal less aggressive investment, reducing competition and helping maintain higher product prices, which results in higher profits at the expense of consumer surplus.
When both firms disclose and invest aggressively, competition intensifies, eroding profits, and this leads to a prisoner’s dilemma where both would have achieved higher profits had they not disclosed.
Under Cournot competition, disclosure of a firm’s cost-reduction investments helps prevent “underinvestment” and provides a competitive edge. When both firms disclose and invest aggressively, competition intensifies, eroding profits, and this leads to a prisoner’s dilemma where both would have achieved higher profits had they not disclosed.
The study demonstrates that firms voluntarily disclose cost information regardless of the competition type when costs are endogenously determined through investment activities. Industries that prioritise cost reduction are predicted to see more voluntary disclosures of gross margins, operating leverage, and cost structures, with less redacted information.
The model predicts a negative association between disclosure and investment in cost reduction under Bertrand competition, but a positive association under Cournot competition. This offers a potential empirical method to determine whether an industry operates under Cournot or Bertrand competition. The findings have significant implications for antitrust regulation and market policy, as the exchange of information among firms is a contentious issue with substantial regulatory attention. To prevent undesired information exchange, regulators may need to discourage disclosure (such as by increasing the cost of disclosure), especially in cases where firms would otherwise choose to do so voluntarily.
The researchers analysed an economy where two firms decide whether to disclose cost information, while also making investment decisions related to cost-reduction technologies. Results show that, regardless of the competition type, firms tend to disclose more cost information when such costs are endogenously determined through their investments. Although the inclination to disclose exists in both markets, the implications for investment behaviour and profits differ. Under Bertrand competition, the equilibrium with disclosure involves less investment and higher profits compared to the scenario of non-disclosure.
These differences suggest that regulators, such as the SEC, might consider making cost disclosures more costly to prevent collusion or excessive investment.
Conversely, under Cournot competition, disclosure leads to more investment but lower profits, compared to nondisclosure. These differences suggest that regulators, such as the SEC, might consider making cost disclosures more costly to prevent collusion or excessive investment. However, the effects of such regulation depend on the market structure. In Cournot markets, increased disclosure costs could reduce competition and harm consumers. In Bertrand markets, it could benefit consumers and society by maintaining higher prices and profits.
The study concludes that firms are inclined to voluntarily disclose their costs, regardless of whether they operate under Cournot or Bertrand competition. Under Bertrand competition, cost disclosure helps firms avoid “overinvestment,” thereby supporting higher prices and profits. Under Cournot competition, cost disclosure encourages overinvestment, which intensifies competition and erodes profits, often trapping firms in a prisoner’s dilemma where neither gains an advantage. Furthermore, the findings suggest that disclosure mandates have limited additional effects because firms tend to disclose voluntarily anyway.
In Cournot markets, such disclosures tend to lower profits but benefit consumers and society by fostering competition. Conversely, in Bertrand markets, disclosures tend to support higher prices and profits. The researchers propose that disclosure strategies often facilitate collusion in markets with strategic complementarities and promote competition where strategies are substitutes, highlighting the strategic role of information exchange in shaping market outcomes.
Keywords: Disclosure, Cournot and Bertrand competition, innovation, cost reduction
* Learn more from the full research article here: https://doi.org/10.2308/TAR-2023-0296
