Endogenous exit costs, government subsidies and exit behavior: A game theoretic perspective of German steel restructuring 1974-1988.

Abstract

The dissertation provides a game theoretic analysis of exit behavior for declining industries and applies the theoretical conclusions to the restructuring of the German steel industry for the time period 1974-88. Using the decline of the German steel industry as an example, the study demonstrates the relevance of two aspects not yet incorporated in the theoretical literature on market exit: the inherent endogeneity of exit costs and the role of political commitments to supply government aid for the firms' exit decisions. The dissertation includes both aspects into the modeling framework and provides a game theoretic interpretation of German steel restructuring. For exit games with eventual stopping, the duration of market participation for individual firms is, ceteris paribus, positively related to the magnitude of the firms' exit cost. The analysis establishes that if firms are sufficiently homogeneous, then incremental increases in one firm's exit cost can alter the order of exit in the unique subgame perfect equilibrium and increase the firm's overall profit. We expect to find increases in exit costs in the form of unilateral commitments by firms predicted to exit early in the original game in order to force rival firms to leave the market first. Alternatively, firms may commit to higher exit cost as a preemptive move to deter rivals from undertaking exit cost enhancing commitments. It holds that firms committing to higher exit costs never exit first. The study documents that redundancy pay specified in so-called "social plans" constituted the primary exit cost for German steel makers and provides a detailed description of the role social plans played in the downsizing of steel operations. The study argues that Saarstahl's '78 restructuring agreement with the IG Metall can be interpreted as an exit cost enhancing commitment with the purpose to alter the equilibrium order of exit. The theoretical model is subsequently extended to formally incorporate the effect of subsidy commitments on the subgame perfect equilibrium in exit choices. The study shows for the case with complete loss coverage that the political commitment to support firms over a finite subsidy spell can lead to a reversal of the equilibrium order of exit. The analysis allows for a characterization of the set of subsidy spells (measured by their relative duration) which guarantees a reversal of the order of exit. The theoretical conclusions are employed to develop a game theoretic perspective of national subsidy practices. The subsidy rivalry between EC member states is explained as an asymmetric Prisoners' Dilemma.