Estimating Models of Firm Entry

National Bureau Of Economic Research Inc, Cambridge MA

Investigators

Abstract

This study estimates models of firm entry and technology adoption for new products, for two different, but related, industries: the automated clearinghouse (ACH) electronic payments technology and automatic teller machines (ATMs). The study analyzes adoption of ACH technology in order to quantify the magnitude of network externalities in the consumer payments industry. In an age in which computers and technology are increasingly prevalent, paper checks remain the dominant payment instrument in the United States. One possible explanation for the lack of usage is network externalities: it is possible that the reason that many consumers and banks have not adopted ACH is simply that there is not a critical mass of users who already are using it. The study will estimate the consumer and bank costs and benefits from ACH adoption using an equilibrium model and data on bank locations, sizes, and usage and adoption of ACH. The study analyzes entry of ATM machines in order to understand the impact of price regulation on firm entry and welfare in a differentiated product environment. Until 1996, major ATM networks fixed the fees that were charged for using an ATM through their network. This system broke down in April 1996, with the result that both the number of ATMs and the price of ATM services increased dramatically. The impact of this change on consumer welfare is ambiguous. ATMs are differentiated products, with a primary characteristic being their location. The increase in the number of ATMs implies that consumers have to travel less to get to an ATM. This decrease in distance can compensate for the increase in price. Using data on locations of ATMs, the study will estimate the fixed costs of ATM operation and consumer disutility from price and distance, and use these to evaluate the welfare impacts of surcharge bans. The study will provide answers to potentially relevant policy questions, such as the costs and benefits of subsidizing ACH adoption and of regulating fees for ATM transactions. Of necessity, the study will answer policy questions by uncovering structural industry parameters, such as consumer utility and bank cost functions. In general, entry decisions by firms in a market are made in simultaneous equilibrium, which implies that straightforward methods to uncover structural parameters are often not valid. Thus, the study will use and extend frontier structural econometric estimation methods. These methods are potentially applicable to a variety of other economic problems. Although the models are stylized descriptions of reality, the study will use transparent sources of data variation that can reasonably attempt to mimic experimental variation. For ACH, the study creates a quasi-experimental source of variation by examining small markets and treating the bank-level adoption decisions by small branches of non-local banks as exogenous to the conditions in the small markets. For ATMs, the study uses state-level regulatory differences, stemming from the fact that the State of Iowa banned most ATM surcharges until early 2002, while neighboring states did not. Thus, this study may also be of use in other economic problems, in that it provides ways in which transparent sources of data variation can be used to estimate structural models.