Basic Equity Question (Herfindahl and Reciprocal of HI)

Equity page 203 #6E 6C has a HI of 6.3 and equivalent # of firms of 16.6 6D has a HI of 7.9 and equivalent # of firms of 12.65 “interpret your answers in terms of the competition structure of the industry” the answer says 6D is more oligopolistic, less competitive Does that mean that a LOWER HI (and subsequently higher equivalent number of firms = MORE COMPETITION, and is that good or bad? In general, is the goal to have a low HI and a high equivalent # of firms? Thanks

Well, it depends. If you’re already an established company within an industry, you would want a higher HI and lower equivalent # of firms. If you are considering entering an industry, it would be easier to enter one with a low HI and higher equivalent # of firms.

Higher profitability is associated with industries having lower concentration and hence less competition (relate this with the competition structure we learned in level 1 Econ). When the HHI is lower, the industry may be in perfect competition and the participants will not be making an economic profit. Companies in Oligopoly can co-operate each other and charge high prices at good times of the economy though they compete heavily during bad time of the economy. As part of the equity analysis, in industry analysis, an industry with higher HHI is favorable to one with lower HHI

thanks for the responses.

CFAI, Equity, pg. 176: “The Herfindahl index has a value that is always smaller than one. A small index indicates a competitive industry with no dominant players.” Also, on pg. 177: “…the higher the Nfirm concentration ratio and the higher the Herfindahl index, the less likely it is that there is cut-throat competition and the more likely it is that companies will cooperate”

Thanks. I also read that same sentences today. Basically I was looking for something simple (Homer Simpson style) like: High Herfindahl Index = good Low Herfindahl Index = bad Instead I got: “A small index indicates a competitive industry with no dominant players.” The seconds quote pretty much nails it, though: “…the higher the Nfirm concentration ratio and the higher the Herfindahl index, the less likely it is that there is cut-throat competition and the more likely it is that companies will cooperate”

High HI = leads to less competition with lower number of players Low HI = leads to more competition with greater number of firms The goal for consumer is to have low HI and higher number of firms so that prices of goods will be lower

> > The goal for consumer is to have low HI and higher > number of firms so that prices of goods will be > lower HHI has nothing to do with the goal of a consumer rather its used for industry analysis in equity valuation.