Potential competition and quality disclosure

Abstract

This study presents a model of quality disclosure in which an incumbent, through its quality and disclosure choices, influences the potential that a new entrant enters the market. In this regard, we consider a sequential framework in which the incumbent chooses its quality and decides whether to disclose it to the market; subsequently, the entrant makes the same decisions, if it enters the market. We show that the potential competition can create strategic incentives for the incumbent to choose nondisclosure, because the availability of information about the incumbent's quality promotes entry by enhancing the entrant's expected profit from the market. In addition, an analysis of the effects of mandatory disclosure laws suggests that they can be effective in encouraging new market entrants and in improving the product quality of established firms.