A model of Firm Exit under Inefficiency and Uncertainty

Simone Pieralli (University of Maryland)
Monday, December 17, 2012 - 2:00pm
Spandauer Strasse 1, Room 23

Uncertainty as well as inefficiency have received extensive attention as potential determinants of firm exit, but only separately. A joint treatment of these two problems is the topic of this paper. In particular, exit under output price uncertainty is considered allowing for inefficiency of firms. Through a real options approach the profit function interacts with inefficiency in defining the level of uncertain price triggering firms’ exit from the market. The proposed methodology allows not specifying a specific production functional form. We derive two classes of profit functions imposing structure on the primal technology. The difference among the classes depends on how the inefficiency is considered. In the first, inefficiency is considered separately from inputs and outputs. In a second specification inefficiency term modifies the production function, directly interacting with inputs and outputs. While in the separable study case inefficiency makes it easier to exit from the market unambiguously, in the non-separable study case this is not necessarily the case. The price triggering exit depends in both cases on the returns to scale parameter in a non-trivial way.