Bankruptcy Risk, Product Market Competition and Horizontal Mergers

We consider an oligopolistic industry including leveraged firms and unleveraged ones where firms are engaged in a sequential decision-making process. At the first stage of the game, a firm and her bank, considering the demand uncertainty and the distribution probability of the shock, evaluate a bankruptcy risk and, at the second stage, firms are engaged in a Cournot competition. We characterize subgame perfect equilibria and we analyze the impact on these equilibria of the proportion of debt financed firms in the industry. By introducing an additionnal upstream stage to the game, we then examine how debt financing impacts on incentives to merge with competitors. We demonstrate that a merger involving leveraged firms increases the bankruptcy probability of the merging firms while a similar merger concerning unleveraged firms or between the two categories of firms leads to a decrease in the bankruptcy probability of leveraged firms. Moreover, the minimum number of firms that must be engaged in the coalition in order to cause a profitable merger, is lower in comparison with Salant, Switzer and Reynolds (1983). The welfare losses associated to anticompetitive effects of mergers are lower when the coalition gathers unleveraged firms rather than leveraged ones. Our model predicts that in evaluating proposed mergers Competition Authorities should take into account the financial structure of both merging firms and outsiders. Moreover the model justifies the failing firm argument when an unleveraged firm takes over a leveraged one.(This abstract was borrowed from another version of this item.)