On the value of incumbency managerial reference points and loss aversion

In discussing market entry decisions and the strategic interaction between an incumbent firm and an entrant, the focus in the literature has been on the different asymmetries that exist between the two. In this paper, we claim that great importance should also be given to the fact that the incumbent firm is in the industry while the entrant is outside the industry. Therefore, even without any other asymmetries, we should expect different behavior from the two types of firms. Making use of the existing literature on decision making under uncertainty, the paper focuses on reference-dependent preferences and on loss aversion. The paper demonstrates that the firms' reference points and loss aversion affect a firm's entry/exit decision, the self-selection of entrants, and the market structure that emerges.