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Bankruptcy Costs and the Theory of Oligopoly

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  • James A. Brander
  • Tracy R. Lewis

Abstract

This paper examines the relationship between financial decisions and output decisions in oligopolistic markets. Assuming a duopoly market structure in which financial decisions and output decisions follow in sequence, the authors analyze how bankrupt cy costs, which are incurred when the firm is unable to meet current debt obligations, affect the firm's behavior in output markets. With fixed bankruptcy costs, firms have an incentive to increase output le vels if they take on more debt. Proportional bankruptcy costs lead to a U-shaped relationship between output and debt. Foresighted owners of firms are led to take into account the strategic output effects of financial structure when considering an optimal financial structure for the firm.

Suggested Citation

  • James A. Brander & Tracy R. Lewis, 1988. "Bankruptcy Costs and the Theory of Oligopoly," Canadian Journal of Economics, Canadian Economics Association, vol. 21(2), pages 221-243, May.
    • Handle: RePEc:cje:issued:v:21:y:1988:i:2:p:221-43
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