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Financial Structure and Product Qualities

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Abstract

We examine the interaction between financial and microeconomic decisions in a differentiated duopoly where additional willingness-to-pay for high quality is uncertain. Product specification is endogenous. We consider two three-stage games, according to the order of moves: qualities-financial structure-prices and financial structure-qualities-prices. Once debt is contracted, the manager maximizes equity instead of total value. We find that in both games debt a) increases both prices and qualities but most likely reduces product differentiation due to rival quality response; b) reduces the value of the levered high quality firm because it increases the low quality. Moreover, c) the cost of debt is higher for the second game, implying that it is higher for projects using debt to finance a product’s development-cumcommercialization compared to those financing only the commercialization stage.

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Bibliographic Info

Paper provided by Department of Economics, University of Macedonia in its series Discussion Paper Series with number 2008_15.

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Date of creation: Dec 2008
Date of revision: Dec 2008
Handle: RePEc:mcd:mcddps:2008_15

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Web page: http://www.uom.gr/index.php?tmima=3

Related research

Keywords: Vertical differentiation; uncertainty; financial structure; leverage; sequential quality choice.;

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  1. Dean Showalter, 1999. "Debt as an Entry Deterrent Under Bertrand Price Competition," Canadian Journal of Economics, Canadian Economics Association, vol. 32(4), pages 1069-1081, August.
  2. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, December.
  3. Constantatos, Christos & Perrakis, Stylianos, 1999. "Free entry may reduce total willingness-to-pay1," Economics Letters, Elsevier, vol. 62(1), pages 105-112, January.
  4. GABSZEWICZ, Jean J. & THISSE, Jacques-François, . "Entry (and exit) in a differentiated industry," CORE Discussion Papers RP -400, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  7. Sudipto Dasgupta & Sheridan Titman, 1996. "Pricing Strategy and Financial Policy," NBER Working Papers 5498, National Bureau of Economic Research, Inc.
  8. Vojislav Maksimovic, 1988. "Capital Structure in Repeated Oligopolies," RAND Journal of Economics, The RAND Corporation, vol. 19(3), pages 389-407, Autumn.
  9. Bulow, Jeremy I & Geanakoplos, John D & Klemperer, Paul D, 1985. "Multimarket Oligopoly: Strategic Substitutes and Complements," Journal of Political Economy, University of Chicago Press, vol. 93(3), pages 488-511, June.
  10. Showalter, Dean M, 1995. "Oligopoly and Financial Structure: Comment," American Economic Review, American Economic Association, vol. 85(3), pages 647-53, June.
  11. Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Wiley Blackwell, vol. 49(1), pages 3-13, January.
  12. Chevalier, Judith A, 1995. " Do LBO Supermarkets Charge More? An Empirical Analysis of the Effects of LBOs on Supermarket Pricing," Journal of Finance, American Finance Association, vol. 50(4), pages 1095-1112, September.
  13. Michel Poitevin, 1989. "Collusion and the Banking Structure of a Duopoly," Canadian Journal of Economics, Canadian Economics Association, vol. 22(2), pages 263-77, May.
  14. Judith A. Chevalier & David S. Scharfstein, 1994. "Capital Market Imperfections and Countercyclical Markups: Theory and Evidence," NBER Working Papers 4614, National Bureau of Economic Research, Inc.
  15. Shaked, Avner & Sutton, John, 1983. "Natural Oligopolies," Econometrica, Econometric Society, vol. 51(5), pages 1469-83, September.
  16. Showalter, Dean, 1999. "Strategic debt: evidence in manufacturing," International Journal of Industrial Organization, Elsevier, vol. 17(3), pages 319-333, April.
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