The Effect of Retail Competition on Relationship-Specific Investments : Evidence from New Car Advertising

Longstanding state regulations restrict car manufacturers from terminating relationships with dealers, creating differences in retail competition across brands and markets. I use this variation to identify the causal effect of dealer competition on dealer and manufacturer advertising. I find that greater intra-brand dealer competition is associated with lower dealer advertising and greater local advertising by manufacturers. The results are evidence that manufacturers can encourage retail relationship-specific investments by providing downstream market power. Additionally, the results provide novel evidence on the substitution of selling effort within vertical relationships and the optimal design of retail networks. I discuss the relevance of these findings to the effects of state automobile franchise regulation and the recent financial troubles of US car manufacturers