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Does product market competition reduce agency costs?

  • Jagannathan, Ravi
  • Srinivasan, Shaker B.

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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Article provided by Elsevier in its journal The North American Journal of Economics and Finance.

Volume (Year): 10 (1999)
Issue (Month): 2 ()
Pages: 387-399

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Handle: RePEc:eee:ecofin:v:10:y:1999:i:2:p:387-399
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/620163

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  1. Nickell, S.J., 1993. "Competition and Crporate Performance," Economics Series Working Papers 99155, University of Oxford, Department of Economics.
  2. 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.
  3. 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.
  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.
  5. Williamson, Oliver E, 1988. " Corporate Finance and Corporate Governance," Journal of Finance, American Finance Association, vol. 43(3), pages 567-91, July.
  6. 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.
  7. 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.
  8. repec:cdl:anderf:5435 is not listed on IDEAS
  9. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  10. Stewart C. Myers, 1984. "Capital Structure Puzzle," NBER Working Papers 1393, National Bureau of Economic Research, Inc.
  11. Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-92, July.
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