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Strategic Debt in Vertical Relationships

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  • Gianni deFraja

    (University of York)

  • Claudio Piga

    (University of Nottingham)

Abstract

We study a vertical relationship between two firms, and we show that the extent of the downstream firm's borrowing affects the contract offered by the upstream firm. We establish a negative relationship between the level of debt and the downstream firm's probability of bankruptcy. We also show that, unless the interest rate is very high, there exists a conflict of interest between the upstream and the downstream firm: the latter wants to take on more debt than the former would like it to. We interpret this finding as an explanation of the constraint imposed by franchisors on the debt level of their franchisees. Such a result is tested using a dataset combining both survey and balance sheet data. We find some support for our theoretical prediction that agent firms can use debt strategically.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 0059.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:0059

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  1. Rajiv Lal, 1990. "Improving Channel Coordination Through Franchising," Marketing Science, INFORMS, vol. 9(4), pages 299-318.
  2. Showalter, Dean M, 1995. "Oligopoly and Financial Structure: Comment," American Economic Review, American Economic Association, vol. 85(3), pages 647-53, June.
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  4. Titman, Sheridan & Wessels, Roberto, 1988. " The Determinants of Capital Structure Choice," Journal of Finance, American Finance Association, vol. 43(1), pages 1-19, March.
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  7. Friend, Irwin & Lang, Larry H P, 1988. " An Empirical Test of the Impact of Managerial Self-interest on Corporate Capital Structure," Journal of Finance, American Finance Association, vol. 43(2), pages 271-81, June.
  8. Francine Lafontaine, 1992. "Agency Theory and Franchising: Some Empirical Results," RAND Journal of Economics, The RAND Corporation, vol. 23(2), pages 263-283, Summer.
  9. Chevalier, Judith A, 1995. "Capital Structure and Product-Market Competition: Empirical Evidence from the Supermarket Industry," American Economic Review, American Economic Association, vol. 85(3), pages 415-35, June.
  10. Sugato Bhattacharyya & Francine Lafontaine, 1995. "Double-Sided Moral Hazard and the Nature of Share Contracts," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 761-781, Winter.
  11. Williamson, Oliver E., 1989. "Transaction cost economics," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 3, pages 135-182 Elsevier.
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  15. Mathewson, G Frank & Winter, Ralph A, 1985. "The Economics of Franchise Contracts," Journal of Law and Economics, University of Chicago Press, vol. 28(3), pages 503-26, October.
  16. Holmstrom, Bengt R. & Tirole, Jean, 1989. "The theory of the firm," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 2, pages 61-133 Elsevier.
  17. Kim, Wi Saeng & Sorensen, Eric H., 1986. "Evidence on the Impact of the Agency Costs of Debt on Corporate Debt Policy," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(02), pages 131-144, June.
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Cited by:
  1. Gianfranco Atzeni & Claudio Piga, 2005. "R&D investment, Credit Rationing and Sample Selection," Discussion Paper Series 2005_6, Department of Economics, Loughborough University, revised Jun 2005.
  2. Antonio Acconcia & Riccardo Martina & Salvatore Piccolo, 2005. "Vertical Restraints under Asymmetric Information: On the Role of Participation Constraints," CSEF Working Papers 141, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 01 Jan 2007.

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