The Role of Capital Structure in Entry-Deterring Capacity Investment

It is shown that the capital structure as well as capacity investment can have a role of precommitment in order to prevent entry. By using debt financing, the incumbent firm will show his aggressive behavior in the post-entry game when they compete with quantity. Thus he can prevent even the potential entrant who can not be deterred by the capacity investment only because it has a relatively low entry cost. When the entry is allowed or blockaded, however, financial structure does not affect the post-entry equilibrium which is different from the results of my first paper where firms make financing decisions simultaneously. When firms compete with price in the post-entry game, debt financing by the incumbent firm shows his less aggressive behavior. Thus the incumbent firm will not use debt financing in order to prevent entry, whereas the potential entrant will use debt financing in order to enter. So a limited leadership possibility can arise by the virtue of the potential entrant's advantage in being the second to make financial decision as well as by the virtue of the incumbent firm's advantage in being the first to make a commitment to capacity and capital structure.