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Financial Structure and Market Equilibrium in a Vertically Differentiated Industry

  • Jean LEFOLL

    ()

    (HEC-University of Geneva and FAME)

  • Stylianos PERRAKIS

    ()

    (John Molson School of Business, Concordia University)

This paper examines the effects of uncertainty and the choice of financial structure in a vertically differentiated duopoly. In the market model consumers are located along a continuum of taste parameters and prefer unanimously higher to lower qualities when quality prices are set at average variable cost. In such a model only two firms can survive with a positive market share. We introduce uncertainty in demand by varying the range of the consumer taste parameter and consider a simultaneous game of sequential choices of quality, financial structure and product price, with varying order of decision-making and revelation of information. We consider both restricted and free entry. It is shown that financial structure affects market equilibrium, which is also heavily dependent on the order of choice of structure and quality, as well as on whether uncertainty exists in the lower or the upper limit of the taste parameter. In all cases leverage increases the lower quality and in most cases it also increases the lower quality price. There are also welfare implications, with the use of leverage when it is optimal improving both total and consumer surplus.

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Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp96.

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Date of creation: Dec 2002
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Handle: RePEc:fam:rpseri:rp96
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  1. Judith A. Chevalier & David S. Scharfstein, 1994. "Capital Market Imperfections and Countercyclical Markups: Theory and Evidence," NBER Working Papers 4614, National Bureau of Economic Research, Inc.
  2. Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Wiley Blackwell, vol. 49(1), pages 3-13, January.
  3. Harris, Milton & Raviv, Artur, 1991. " The Theory of Capital Structure," Journal of Finance, American Finance Association, vol. 46(1), pages 297-355, March.
  4. Chevalier, Judith A, 1995. " Do LBO Supermarkets Charge More? An Empirical Analysis of the Effects of LBOs on Supermarket Pricing," Journal of Finance, American Finance Association, vol. 50(4), pages 1095-1112, September.
  5. Michel Poitevin, 1989. "Collusion and the Banking Structure of a Duopoly," Canadian Journal of Economics, Canadian Economics Association, vol. 22(2), pages 263-77, May.
  6. Constantatos, Christos & Perrakis, Stylianos, 1997. "Vertical differentiation: Entry and market coverage with multiproduct firms," International Journal of Industrial Organization, Elsevier, vol. 16(1), pages 81-103, November.
  7. Shaked, Avner & Sutton, John, 1983. "Natural Oligopolies," Econometrica, Econometric Society, vol. 51(5), pages 1469-83, September.
  8. Showalter, Dean M, 1995. "Oligopoly and Financial Structure: Comment," American Economic Review, American Economic Association, vol. 85(3), pages 647-53, June.
  9. Vojislav Maksimovic, 1988. "Capital Structure in Repeated Oligopolies," RAND Journal of Economics, The RAND Corporation, vol. 19(3), pages 389-407, Autumn.
  10. Dasgupta, Sudipto & Titman, Sheridan, 1998. "Pricing Strategy and Financial Policy," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 705-37.
  11. GABSZEWICZ, Jean J. & THISSE, Jacques-François, . "Entry (and exit) in a differentiated industry," CORE Discussion Papers RP 400, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  12. Bulow, Jeremy I & Geanakoplos, John D & Klemperer, Paul D, 1985. "Multimarket Oligopoly: Strategic Substitutes and Complements," Journal of Political Economy, University of Chicago Press, vol. 93(3), pages 488-511, June.
  13. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, June.
  14. Constantatos, Christos & Perrakis, Stylianos, 1999. "Free entry may reduce total willingness-to-pay1," Economics Letters, Elsevier, vol. 62(1), pages 105-112, January.
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