Essays on China\u27s Cigarette Industry

This dissertation comprises three chapters on the Chinese cigarettes industry. The China State Tobacco Monopoly Administration (STMA) regulates this industry, allocating quotas of production across manufacturers. Between 2006 and 2007, it mandated all cigarette firms within a province merge into a single state-owned, province-level firm. After the merger, the province-level firms allocate their quotas for the maximum number of cartons they can produce directly. In the first chapter, I examine how the mandated change in market structure resulting from the STMA affected allocation on the quality dimension. To assess the pre-merger differences in market structure in quota allocation, I compare the changes in cigarette quality in provinces that initially had only one firm, hence whose market structure did not change, with those that initially had multiple firms. I construct a theoretical model for the monopoly market and the duopoly market. The model predicts that when there is regional competition, the proportion of high-quality cigarettes is lower than in a monopoly market. I use an event study method and a triple-differences model to identify the changes in the quality composition at the province-level before and after the merger by comparing two types of reorganization. I find that the consolidation mandated by the merger is associated with increases in product quality. I use the incentives of managers in monopoly and oligopoly markets to explain the shift in quality choices of firms in the provinces affected by the STMA mandate. My second paper presents the analysis of the effect of the mandated merger on inventory. The Chinese cigarette industry provides an excellent opportunity to study a market with the characteristics of inflexible prices and uncertain demand. In this paper, I provide a theoretical model to take into account the demand uncertainty and different market structures to predict how the mandated consolidation as an exogenous shock affects the inventory. Based on the theoretical model, if there are competitors in the region, which is a duopoly market, managers choose non-cooperative strategies by producing more high-quality cigarettes to steal their competitors\u27 high-segment markets for higher profit margins, which leads to higher inventories. My empirical analysis confirms these effects of high-quality cigarettes and medium-quality cigarettes. My third chapter presents the welfare analysis of the effect of horizontal mergers. Based on the theoretical model in Chapter One, after the reform, the consumers who can buy the cigarettes with desired characteristics increases. The consumer\u27s welfare increases as a result of the consolidation. On the other hand, producer welfare increases because of the lower dollar value of the inventory