Review of Industrial Organization 14: 377–390, 1999.
© 1999 Kluwer Academic Publishers. Printed in the Netherlands.
Market Power, Efﬁciency and the Dispersion of
DONALD L. ALEXANDER AND PAUL D. THISTLE
Department of Economics, Western Michigan University, 1201 Oliver St., Kalamazoo, MI 49008
Abstract. A number of studies have used the Capital Asset Pricing Model (CAPM) to integrate
product market and ﬁnancial theories of the ﬁrm. We reexamine the relationship between product
market structure and systematic risk at the ﬁrm and industry level. We show that theory yields no
testable implications at the ﬁrm level. We show, however, that there is a relationship between the
intraindustry dispersion of systematic risk and industry concentration which depends on the causes
and consequences of concentration. Estimates of the relationship between the intraindustry variance
of β and concentration for a 1987 cross-section of U.S. industries suggest that concentration allows
larger ﬁrms to exercise market power.
Key words: Market power, CAPM, concentration, efﬁciency, entry barriers, systematic risk
JEL Classiﬁcation: L1, G0
The risks that ﬁrms face generally originate in the ﬁrm’s operations in product
and factor markets due, for example, to random variations in product demand
or in factor prices. However, the effect of these risks on the value of the ﬁrm
is determined in ﬁnancial markets. The integration of the theory of the ﬁrm in
product and ﬁnancial markets has been the objective of a number of studies (e.g.,
Booth, 1981; Gomes and Islam, 1989; Hite, 1977; Lee et al., 1990; Subrahmanyam
and Thomadakis, 1980; Thomadakis, 1976). These studies have used the Capital
Asset Pricing Model (CAPM) to derive the relationship between product market
characteristics and the ﬁrm’s systematic risk.
This literature has focused on the relationship between market power and sys-
tematic risk, in part because of the long-standing concern in industrial organization
that market power may confer advantages in capital markets, which may then
serve as an additional barrier to entry.
Subrahmanyam and Thomadakis (1980),
Jose and Stevens (1987), Booth (1981) and Lee et al. (1990) showed that there
is an inverse relationship between a monopolist’s systematic risk and its market
We would like to thank Don Meyer and the referee for helpful comments and Firas Alkhaldi,
Keith Erwin and Tim Mullalay for valuable research assistance.
See, for example, the discussion in Scherer (1980; pp. 104–108).