The Effects of Market Concentration and Market Power on Cost Structure

Abstract

This study investigates the association between market structure and cost structure using a national sample of U.S. hospitals. Cost structure, which is difficult to alter in the short run, determines operating risk; therefore, it is important to understand factors that influence managerial choices on cost structure. Market structure is a potentially important determinant of cost structure because managers' investment decisions are influenced by how the firm interacts with rival firms and suppliers (e.g., Caballero 1991;Grenadier 2002;Novy-Marx 2007). Yet, market structure has received little attention from accounting researchers. We measure market structure with market concentration and market power. Market concentration, which is the same for all market participants, reflects the overall competitiveness of the market. Market power, which varies by market participant, captures each market participant's competitive standing relative to the market. Results indicate that: 1) hospitals in more concentrated markets adopt more rigid cost structures, 2) hospitals with market power adopt more elastic cost structures, and 3) market power magnifies the positive relation between demand uncertainty and cost elasticity. The market concentration result is consistent with the premise that higher margins in more concentrated markets provide a larger incentive for these hospitals to invest. The market power results suggest that hospitals with market power face lower transaction costs, which enable them to maintain more elastic cost structures and alter their cost structures more easily in response to changes in demand uncertainty.