Strategic Commitment versus Flexibility in a Duopoly with Entry and Exit

This paper examines how differences in the opportunity costs of assets employed by firms affect the trade-off between the commitment to a particular course of action and the flexibility to revise past actions. The setup is characterized by two firms that have to decide at each instant of time whether to be in or out of an industry that is assumed to expand up to a maturity date uncertain to the companies, declining until it disappears thereafter. Firms differ only on the opportunity costs of the resources they possess, and thus their investments are not equally recoverable, which allows for the analysis of whether or not a firm benefits from competing with the assets whose outside option is most valuable. I characterize the path associated to the unique subgame perfect equilibrium of the game and pay special attention to the role of opportunity costs in explaining differences in equilibrium payoffs as well as in entry and exit timing. The analysis provides conditions under which the high-opportunity-cost firm enters first and gains a higher payoff. Key words: Opportunity costs of assets, war of attrition, preemption, real options and industry dynamics