Capacity preemption and leadership contest in a market with uncertainty, working paper

This paper introduces a continuous-time game to study two ex ante identical firms ’ incentives in capacity preemption. Each firm can choose small or large capacity and investment timing to enter a new industry whose demand grows until an unknown maturity date and then declines until it disappears. Previous literature usually predicts that the Stackelberg leader, whether endogenously or exogenously determined, is better off by building a larger capacity than its rival. In contrast, this paper proves that in most cases the first mover’s equilibrium strategy is to enter with a smaller capacity than the follower. If the first mover had chosen the larger capacity, its follower could, and in fact would use a smaller plant to force it out of the market through a leadership contest. The large leader lacks incentive to fight for the market because the small firm can make a credible commitment to stay with its higher option value of waiting to exit.