Review of Industrial Organization 24: 285–299, 2004.
© 2004 Kluwer Academic Publishers. Printed in the Netherlands.
Licensing Requirements as a Coordination
Mechanism for Entry
University of Wyoming, Department of Economics and Finance (Department 3985), 1000 E.
University Ave., Laramie, WY 82071, U.S.A.,
Abstract. Cheap talk, side payments, and arbitration are limited in their ability to coordinate asym-
metric entry among symmetric potential entrants. Externally imposed licensing requirements may
provide a viable mechanism to attain the desired asymmetric outcome in equilibrium.
Key words: Coordination mechanism, entry, licensing
When simultaneous entry is possible and there are more potential entrants than
the market can sustain, a problem arises in coordinating entry. The problem is
particularly severe if potential entrants are identical, so that the asymmetry charac-
terizing the ﬁrst-best outcome must somehow be attained from an initial position
of symmetry. The need to coordinate entry in such circumstances has long been
recognized and continues to command attention; see for example Dixit and Shapiro
(1986), Nti (1989), and Elberfeld and Wolfstetter (1999). The ﬂavor of the results
of this literature is typiﬁed by Nti (2000), who shows that a risk of uncoordinated
entry can actually discourage entry, so that welfare may be a decreasing function of
potential competition. To the extent that mechanisms have been explored to achieve
coordination, the ﬁndings have generally also been pessimistic; for example, Kang
and Lee (2001) show that a contest for the right to enter can dissipate resources in
excess of the expected increase in social welfare from entry.
Farrell (1987) has shown that cheap talk (costless, nonbinding, nonveriﬁable
communication) prior to entry can achieve partial coordination in this situation.
Two primary shortcomings are associated with the cheap talk mechanism. One is
that the socially optimal asymmetric outcome is not attained with certainty. The
The outcome of excess entry may be viewed as related to the possibility of ruinous competi-
tion, which has been suggested both theoretically (Calem, 1992; Fishburn and Odlyzko, 1999) and
empirically (Chandler, 1977, p. 134; Bittlingmayer, 1982; Perry, 1986; Henning, 1992).