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Debt, Investment, and Product Market Competition

  • Matthew J. Clayton
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    Recent empirical literature on the interaction between capital structure, investment, and product market decisions suggests that debt leads to lower investment expenditures and weaker product market competition. Theoretical literature in this area has been unable to fully explain this finding (perhaps because all theoretical papers look only at two of the above decisions). This paper develops a model which examines all three decisions and shows that debt and investment can be substitutes in a model where firms rationally take on debt. Furthermore, it is demonstrated that when firms compete with prices in the product market, an increase in debt leads to lower investment and higher prices.

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    File URL: http://www.stern.nyu.edu/fin/workpapers/papers99/wpa99056.pdf
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    Paper provided by New York University, Leonard N. Stern School of Business- in its series New York University, Leonard N. Stern School Finance Department Working Paper Seires with number 99-056.

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    Date of creation: Jan 1999
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    Handle: RePEc:fth:nystfi:99-056
    Contact details of provider: Postal: U.S.A.; New York University, Leonard N. Stern School of Business, Department of Economics . 44 West 4th Street. New York, New York 10012-1126
    Phone: (212) 998-0100
    Web page: http://w4.stern.nyu.edu/finance/

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    1. Chaim Fershtman & Kenneth L Judd, 1984. "Equilibrium Incentives in Oligopoly," Discussion Papers 642, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    2. James A. Brander & Barbara J. Spencer, 1983. "Strategic Commitment with R&D: The Symmetric Case," Bell Journal of Economics, The RAND Corporation, vol. 14(1), pages 225-235, Spring.
    3. Phillips, Gordon M., 1995. "Increased debt and industry product markets An empirical analysis," Journal of Financial Economics, Elsevier, vol. 37(2), pages 189-238, February.
    4. Kovenock, Dan & Phillips, Gordon M, 1997. "Capital Structure and Product Market Behavior: An Examination of Plant Exit and Investment Decisions," Review of Financial Studies, Society for Financial Studies, vol. 10(3), pages 767-803.
    5. Hart, Oliver D & Tirole, Jean, 1988. "Contract Renegotiation and Coasian Dynamics," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 509-40, October.
    6. Rotemberg, Julio J & Scharfstein, David S, 1990. "Shareholder-Value Maximization and Product-Market Competition," Review of Financial Studies, Society for Financial Studies, vol. 3(3), pages 367-91.
    7. Bengt Holmstrom & Roger B. Myerson, 1981. "Efficient and Durable Decision Rules with Incomplete Information," Discussion Papers 495, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    8. Fulghieri, P. & Nagarajan, S., 1991. "Financial Contracts as Lasting Commitments: The Case of Leveraged Oligopoly," Papers 92-01, Columbia - Graduate School of Business.
    9. Bolton, Patrick & Scharfstein, David S, 1990. "A Theory of Predation Based on Agency Problems in Financial Contracting," American Economic Review, American Economic Association, vol. 80(1), pages 93-106, March.
    10. Kaplan, Steven, 1989. "The effects of management buyouts on operating performance and value," Journal of Financial Economics, Elsevier, vol. 24(2), pages 217-254.
    11. Chevalier, Judith A, 1995. "Capital Structure and Product-Market Competition: Empirical Evidence from the Supermarket Industry," American Economic Review, American Economic Association, vol. 85(3), pages 415-35, June.
    12. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    13. Showalter, Dean M, 1995. "Oligopoly and Financial Structure: Comment," American Economic Review, American Economic Association, vol. 85(3), pages 647-53, June.
    14. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
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