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Debt, Investment, and Product Market Competition

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  • Matthew J. Clayton

Abstract

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.

Suggested Citation

  • Matthew J. Clayton, 1999. "Debt, Investment, and Product Market Competition," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-056, New York University, Leonard N. Stern School of Business-.
  • Handle: RePEc:fth:nystfi:99-056
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    File URL: http://www.stern.nyu.edu/fin/workpapers/papers99/wpa99056.pdf
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    References listed on IDEAS

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    3. 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.
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    5. Holmstrom, Bengt & Myerson, Roger B, 1983. "Efficient and Durable Decision Rules with Incomplete Information," Econometrica, Econometric Society, vol. 51(6), pages 1799-1819, November.
    6. Fulghieri, Paolo & Nagarajan, S., 1992. "Financial contracts as lasting commitments: The case of a leveraged oligopoly," Journal of Financial Intermediation, Elsevier, vol. 2(1), pages 2-32, March.
    7. 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 367-391.
    8. 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 415-435, June.
    9. 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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    11. 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.
    12. Oliver D. Hart & Jean Tirole, 1988. "Contract Renegotiation and Coasian Dynamics," Review of Economic Studies, Oxford University Press, vol. 55(4), pages 509-540.
    13. 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.
    14. Kaplan, Steven, 1989. "The effects of management buyouts on operating performance and value," Journal of Financial Economics, Elsevier, vol. 24(2), pages 217-254.
    15. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
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    Cited by:

    1. Istaitieh, Abdulaziz & Rodriguez-Fernandez, Jose M., 2006. "Factor-product markets and firm's capital structure: A literature review," Review of Financial Economics, Elsevier, vol. 15(1), pages 49-75.
    2. Matthew J. Clayton & S. Abraham Ravid, 1999. "The Effect of Leverage on Bidding Behavior: Theory and Evidence from the FCC Auctions," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-055, New York University, Leonard N. Stern School of Business-.

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