Competition and Subsidies in the Deregulated U.S. Local Telephone Industry∗

The 1996 Telecommunications Act opened the monopolistic U.S. local telephone industry to new entrants. However, substantial entry costs have prevented some markets from becoming competitive. We study various subsidy policies designed to encourage entry. We estimate a dynamic entry game using data on both potential and actual entrants, allowing for heterogeneous option values of waiting. We find that subsidies to smaller markets are more cost-effective in reducing monopoly markets, but subsidies to only lower-cost firms are less cost-effective than a nondiscriminatory policy. Subsidies in only early periods reduce the option value of waiting and accelerate the arrival of competition.