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On the Strategic Use of Debt and Capacity in Imperfectly Competitive Product Markets

Author

Listed:
  • Leach, J. Chris

    () (Leeds School of Business, University of Colorado at Boulder)

  • Moyen, Nathalie

    (Leeds School of Business, University of Colorado at Boulder)

  • Yang, Jing

    (California State University, Fullerton)

Abstract

In capital intensive industries, firms face complicated multi-stage financing, investment, and production decisions under the watchful eye of existing and potential industry rivals. We consider a two-stage simplification of this environment. In the first stage, an incumbent firm benefits from two first-mover advantages by precommiting to a debt financing policy and a capacity investment policy. In the second stage, the incumbent and a single-stage rival simultaneously choose production levels and realize stochastic profits. We characterize the incumbent's first-stage debt and capacity choices as factors in the production of an intermediate good we call "output deterrence." In our two-factor deterrence model, we show that the incumbent chooses a unique capacity policy and a threshold debt policy to achieve the optimal level of deterrence coinciding with full Stackelberg leadership. When we remove the incumbent's first-mover advantage in capacity, the full Stackelberg level of deterrence is still achievable, albeit with a higher level of debt than the threshold. In contrast, when we remove the incumbent's first-mover advantage in debt, the Stackelberg level of deterrence may no longer be achievable and the incumbent may suffer a dead-weight loss. Evidence on the telecommunications industry shows that firms have increased their leverage in a manner consistent with deterring potential rivals following the 1996 deregulation.

Suggested Citation

  • Leach, J. Chris & Moyen, Nathalie & Yang, Jing, 2004. "On the Strategic Use of Debt and Capacity in Imperfectly Competitive Product Markets," SIFR Research Report Series 33, Institute for Financial Research.
  • Handle: RePEc:hhs:sifrwp:0033
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    References listed on IDEAS

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    Cited by:

    1. Matthew Spiegel & Heather Tookes, 2008. "Dynamic Competition, Innovation and Strategic Financing," Yale School of Management Working Papers amz2500, Yale School of Management.

    More about this item

    Keywords

    Industrial organization; Deregulation; Deterrence; Capital structure; Capacity; Telecommunications;

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L96 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Telecommunications

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