Causality and the Concentration Profits Controversy

Abstract

Interindustry, cross-sectional studies of concentration and profitability assume, according to the market power doctrine, that concentration is an exogeneous variable, though this notion has been questioned at different times by a number of industrial organization economists. This study uses a time series approach to test the correctness of the conventional notion that market share determines profitability of an individual firm. Sims' causality tests were performed for three separate firms and the interrelationships over time between the firm's market share and rate of return were estimated (i.e., do changes in a firm's market share occur prior to changes in the firm's rate of return or do changes in the firm's rate of return occur prior to changes in a firm's market share). Two of the three firms examined failed to exhibit the unidirectional causality assumed by the conventional structure-performance paradigm. These results suggest that the cross-section, interindustry approach often uses industries as cases, which are aggregated from firms wherein the direction of causality of the profitability variable cannot be assumed.