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External Financing and Customer Capital: A Financial Theory of Markups

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  • Winston Wei Dou

    (The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104,)

  • Yan Ji

    (The Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong)

Abstract

We develop a continuous-time industry equilibrium model of monopolistic competition to understand how product markups are determined in the presence of external financing costs and customer capital. Firms optimally set markups to balance the tradeoff between profiting from their existing customer base and developing their future customer base. We characterize how the equilibrium markups are determined by the interaction between the marginal value of corporate liquidity and the marginal value of customer base. Firms’ markups are more responsive to changes in their marginal value of corporate liquidity when the marginal value of customer base is higher. Moreover, the model predicts that greater product market threats lead to more conservative financial policies, which is supported by the data.

Suggested Citation

  • Winston Wei Dou & Yan Ji, 2021. "External Financing and Customer Capital: A Financial Theory of Markups," Management Science, INFORMS, vol. 67(9), pages 5569-5585, September.
    • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:9:p:5569-5585
    DOI: 10.1287/mnsc.2020.3739
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