Does product market competition reduce agency costs?
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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Volume (Year): 10 (1999)
Issue (Month): 2 ()
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References listed on IDEAS
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- Glazer, Jacob & Israel, Ronen, 1990. "Managerial incentives and financial signaling in product market competition," International Journal of Industrial Organization, Elsevier, vol. 8(2), pages 271-280, June.
- Myers, Stewart C., 1984. "Capital structure puzzle," Working papers 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- repec:cdl:anderf:5435 is not listed on IDEAS
- Stewart C. Myers, 1984. "Capital Structure Puzzle," NBER Working Papers 1393, National Bureau of Economic Research, Inc.
- Nickell, S.J., 1993.
"Competition and Crporate Performance,"
Economics Series Working Papers
99155, University of Oxford, Department of Economics.
- Titman, Sheridan & Wessels, Roberto, 1988. " The Determinants of Capital Structure Choice," Journal of Finance, American Finance Association, vol. 43(1), pages 1-19, March.
- Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-92, July.
- Fama, Eugene F, 1980. "Agency Problems and the Theory of the Firm," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 288-307, April.
- 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 20-85, Wharton School Rodney L. White Center for Financial Research.
- Williamson, Oliver E, 1988. " Corporate Finance and Corporate Governance," Journal of Finance, American Finance Association, vol. 43(3), pages 567-91, July.
- Titman, Sheridan, 1984. "The effect of capital structure on a firm's liquidation decision," Journal of Financial Economics, Elsevier, vol. 13(1), pages 137-151, March.
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