Bailouts and the Preservation of Competition

Governments rescue private companies partly to prevent other firms from gaining excessive market power. However, if failing firms exit, new entry may limit remaining firms' market power if there are potential entrants who can be as effective competitors as the firms leaving the market. We quantify these effects in the case of the 1984 bailout of timber companies that faced substantial losses on existing federal timber contracts. We predict that the bailout substantially increased sale prices in subsequent auctions because firms that might have might have been induced to enter without the bailout tended to have relatively low values.