Screening Through Investment: Evidence from the Chinese Automobile Industry

Wei LIN, Frank MATHEWSON, Junji XIAO*

*Corresponding author for this work

Research output: Journal PublicationsJournal Article (refereed)peer-review

Abstract

This paper proposes a competition theory to explain the role of automobile dealers’ investment in a vertical contract with manufacturers. Dealer contracts specify manufacturer-suggested retail prices and elements of dealer quality. Dealer quality investments require minimum financial capital where manufacturers impose these limits on dealers. The required dealer investment screens for qualified dealers and incentivizes the desired dealer quality. The prediction is that promotional services, prices, and gross returns are greater for high-quality brands than that for standard-quality brands. To test the theory, we collected data on auto dealers in China in June 2015 for an empirical analysis. Our findings support these predictions: Dealer investment (registered capital) is positively correlated with brand average product prices. In addition, the registered capital is higher when the aggregate demand is greater since high demand increases returns, which induces dealers to increase their investment.
Original languageEnglish
JournalReview of Industrial Organization
Early online date11 Mar 2024
DOIs
Publication statusE-pub ahead of print - 11 Mar 2024

Bibliographical note

Publisher Copyright:
© The Author(s) 2024.

Keywords

  • Chinese automobile industry
  • Dealer investment
  • Screening mechanism
  • Vertical restraints

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