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Outsourcing and Financing Decisions in Industry Equilibrium

Author

Listed:
  • George Kanatas
  • Jianping Qi

Abstract

In a competitive product market, firms that buy their input have lower profit volatility than they would have if they were to make it. This effect on profit volatility is an important consideration in the firms’ capital structure choices and their make or buy decisions when it interacts with the risk-taking incentive of equityholders of levered firms. Even with a cost advantage enjoyed by a supplier and passed on to its customers, in an industry equilibrium of a priori identical firms, only those that use little or no debt outsource their input to the supplier; all significantly debt-financed firms produce their own input and take advantage of the greater profit volatility resulting from internal production.

Suggested Citation

  • George Kanatas & Jianping Qi, 2016. "Outsourcing and Financing Decisions in Industry Equilibrium," Review of Finance, European Finance Association, vol. 20(6), pages 2247-2271.
    • Handle: RePEc:oup:revfin:v:20:y:2016:i:6:p:2247-2271.
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    File URL: http://hdl.handle.net/10.1093/rof/rfv067
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    References listed on IDEAS

    as
    1. Demski, Js & Sappington, Dem, 1993. "Sourcing With Unverifiable Performance Information," Journal of Accounting Research, Wiley Blackwell, vol. 31(1), pages 1-20.
    2. Brander, James A. & Lewis, Tracy R., 1986. "Oligopoly and Financial Structure: The Limited Liability Effect," American Economic Review, American Economic Association, vol. 76(5), pages 956-970, December.
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    Cited by:

    1. Friedrich, Benjamin U. & Zator, Michał, 2023. "Flexibility costs of debt: Danish exporters during the cartoon crisis," Journal of Financial Economics, Elsevier, vol. 148(2), pages 91-117.
    2. Benjamin U. Friedrich & Michal Zator, 2018. "Adaptation to Shocks and The Role of Capital Structure: Danish Exporters During the Cartoon Crisis," Economics Working Papers 2018-12, Department of Economics and Business Economics, Aarhus University.

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    More about this item

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L23 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Organization of Production

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