Financial Signalling and the "Deep Pocket" Argument
This Paper Provides a Formal Representation of Telser (1966)'S Deep Pocket Argument. According to Telser, Predation May Take Place Because Typical Entrants Are More Vulnerable Financially Than Are Typical Incubents. We Propose That Entrants' Financial Vulnerability May Be Explained by Informational Problems in Financial Markets. We Model a Situation in Which Financiers Are Uncertain of the True Value of an Entrant. At the Same Time, Financiers Know the Incubent's True Value. Both Types of Firm Have to Finance a Fixed Expenditure Before Starting Production. in Equilibrium, the Incubent Finances with Equity, While the High Value Entrant Must Issue Debt to Signal Its Quality to Investors. It Enters the Market Heavily Leveraged Compare to the Incubent. This Provides Incentives for the Incubent to Engage in a Price War to Financially Exhaust the Entrant and Cause Its Bankruptcy. the Price War May Be Intepreted As the Incubent's Predatory Response to the Entrant's Leveraged Entry. a Diversified Pool of Undistinguishable Entrants Is Sufficient to Justify the Deep Pocket Argument Put Forward by Telse (1966). We Base Ou Explanation on the Presence of Asymmetric Information in Financial and Output Markets.
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