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Does Product Market Competition Reduce Agency Costs?

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  • Ravi Jagannathan
  • Shaker B. Srinivasan

Abstract

The folk wisdom is that competition reduces agency costs. We provide indirect empirical support for this view. We argue that the temptation to retain cash and engage in less productive activities is more severe for firms in less competitive industries. Hence an unanticipated increase in cash-flow due to higher past returns is more likely to lead to a reduction in leverage as well as a lowering of future returns for firms in less competitive environments. Current leverage will therefore be negatively related to past returns and positively related to future returns for such firms. In contrast, for firms in more competitive industries, the negative relation between past returns and current leverage will be attenuated. Theory suggests that the relation between current leverage and future returns for such firms will be zero or negative. Using a proxy to distinguish firms in less competitive industries and data for 165 single business firms in the U.S.A., we provide empirical supports for our arguments.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7480.

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Date of creation: Jan 2000
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Publication status: published as North American Journal of Economics and Finance (special Finance Issue), Volume: 10 Issue: 2 Pages: 387-399 (1999)
Handle: RePEc:nbr:nberwo:7480

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  1. Nickell, S.J., 1993. "Competition and Crporate Performance," Economics Series Working Papers, University of Oxford, Department of Economics 99155, University of Oxford, Department of Economics.
  2. Fama, Eugene F, 1980. "Agency Problems and the Theory of the Firm," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(2), pages 288-307, April.
  3. Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, American Finance Association, vol. 39(3), pages 575-92, July.
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  5. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  6. Williamson, Oliver E, 1988. " Corporate Finance and Corporate Governance," Journal of Finance, American Finance Association, American Finance Association, vol. 43(3), pages 567-91, July.
  7. Glazer, Jacob & Israel, Ronen, 1990. "Managerial incentives and financial signaling in product market competition," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 8(2), pages 271-280, June.
  8. Stewart C. Myers, 1984. "Capital Structure Puzzle," NBER Working Papers 1393, National Bureau of Economic Research, Inc.
  9. Titman, Sheridan, 1984. "The effect of capital structure on a firm's liquidation decision," Journal of Financial Economics, Elsevier, Elsevier, vol. 13(1), pages 137-151, March.
  10. Titman, Sheridan & Wessels, Roberto, 1988. " The Determinants of Capital Structure Choice," Journal of Finance, American Finance Association, American Finance Association, vol. 43(1), pages 1-19, March.
  11. Franklin Allen, . "Capital Structure and Imperfect Competition in Product Markets (Revision of 24-84; Revised: 11-87)," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 20-85, Wharton School Rodney L. White Center for Financial Research.
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Cited by:
  1. Gaetan Nicodeme & Jacques-Bernard Sauner-Leroy, 2004. "Product market reforms and productivity: a review of the theoretical and empirical literature on the transmission channels," European Economy - Economic Papers, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission 218, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  2. Campbell R. Harvey & Karl V. Lins & Andrew H. Roper, 2001. "The Effect of Capital Structure When Expected Agency Costs are Extreme," NBER Working Papers 8452, National Bureau of Economic Research, Inc.
  3. Massa, Massimo & Rehman, Zahid & Vermaelen, Theo, 2007. "Mimicking repurchases," Journal of Financial Economics, Elsevier, Elsevier, vol. 84(3), pages 624-666, June.
  4. Fabio Schiantarelli, 2005. "Product Market Regulation and Macroeconomic Performance: A Review of Cross Country Evidence," Boston College Working Papers in Economics, Boston College Department of Economics 623, Boston College Department of Economics, revised 04 Aug 2008.
  5. Ahmed Ennasri, 2010. "Incitations Managériales et Concurrence : Synthèse de la Littérature," Studies and Syntheses, LAMETA, Universtiy of Montpellier 10-03, LAMETA, Universtiy of Montpellier, revised Oct 2010.
  6. Datta, Sudip & Iskandar-Datta, Mai & Singh, Vivek, 2013. "Product market power, industry structure, and corporate earnings management," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(8), pages 3273-3285.
  7. Bushman, Robert M. & Smith, Abbie J., 2001. "Financial accounting information and corporate governance," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 32(1-3), pages 237-333, December.
  8. Hashem Valipour & Javad Moradi & Ehsan Heshmatzade, 2013. "Studying the Effect of Market Competition on the Auditing Fees and the Operational Costs Efficiency as the Agency Costs Indexes," International Journal of Academic Research in Accounting, Finance and Management Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Accounting, Human Resource Management Academic Research Society, International Journal of Academic Research in Accounting, Finance and Management Sciences, vol. 3(3), pages 95-104, July.

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