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Bankruptcy Risk, Product Market Competition and Horizontal Mergers

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  • Barnard Franck
  • Nicolas Le Pape

Abstract

We consider an oligopolistic industry including leveraged firms and unleveraged ones where firms are engaged in a sequential decision-making process. At the first stage of the game, a firm and her bank, considering the demand uncertainty and the distribution probability of the shock, evaluate a bankruptcy risk and, at the second stage, firms are engaged in a Cournot competition. We characterize subgame perfect equilibria and we analyze the impact on these equilibria of the proportion of debt financed firms in the industry. By introducing an additionnal upstream stage to the game, we then examine how debt financing impacts on incentives to merge with competitors. We demonstrate that a merger involving leveraged firms increases the bankruptcy probability of the merging firms while a similar merger concerning unleveraged firms or between the two categories of firms leads to a decrease in the bankruptcy probability of leveraged firms. Moreover, the minimum number of firms that must be engaged in the coalition in order to cause a profitable merger, is lower in comparison with Salant, Switzer and Reynolds (1983). The welfare losses associated to anticompetitive effects of mergers are lower when the coalition gathers unleveraged firms rather than leveraged ones. Our model predicts that in evaluating proposed mergers Competition Authorities should take into account the financial structure of both merging firms and outsiders. Moreover the model justifies the failing firm argument when an unleveraged firm takes over a leveraged one.
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  • Barnard Franck & Nicolas Le Pape, 2010. "Bankruptcy Risk, Product Market Competition and Horizontal Mergers," TEPP Working Paper 2010-19, TEPP.
  • Handle: RePEc:tep:teppwp:wp10-19
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    References listed on IDEAS

    as
    1. Ziss, Steffen, 2001. "Horizontal mergers and delegation," International Journal of Industrial Organization, Elsevier, vol. 19(3-4), pages 471-492, March.
    2. Levin, Dan, 1990. "Horizontal Mergers: The 50-Percent Benchmark," American Economic Review, American Economic Association, vol. 80(5), pages 1238-1245, December.
    3. Krakel, Matthias & Sliwka, Dirk, 2006. "Strategic delegation and mergers in oligopolistic contests," Journal of Economics and Business, Elsevier, vol. 58(2), pages 119-136.
    4. Stephen W. Salant & Sheldon Switzer & Robert J. Reynolds, 1983. "Losses From Horizontal Merger: The Effects of an Exogenous Change in Industry Structure on Cournot-Nash Equilibrium," The Quarterly Journal of Economics, Oxford University Press, vol. 98(2), pages 185-199.
    5. Franck, Bernard & Le Pape, Nicolas, 2008. "The commitment value of the debt: A reappraisal," International Journal of Industrial Organization, Elsevier, vol. 26(2), pages 607-615, March.
    6. Mason, Robin & Weeds, Helen, 2002. "The Failing Firm Defence: Merger Policy and Entry," CEPR Discussion Papers 3664, C.E.P.R. Discussion Papers.
    7. Fershtman, Chaim & Judd, Kenneth L, 1987. "Equilibrium Incentives in Oligopoly," American Economic Review, American Economic Association, vol. 77(5), pages 927-940, December.
    8. Alessandro Fedele & Massimo Tognoni, 2010. "Failing Firm Defence With Entry Deterrence," Bulletin of Economic Research, Wiley Blackwell, vol. 62(4), pages 365-386, October.
    9. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    10. Morton I. Kamien & Israel Zang, 1990. "The Limits of Monopolization Through Acquisition," The Quarterly Journal of Economics, Oxford University Press, vol. 105(2), pages 465-499.
    11. M. Pilar Socorro, 2007. "Mergers Under Uncertainty: The Effects Of Debt Financing," Manchester School, University of Manchester, vol. 75(5), pages 580-597, September.
    12. Raymond Deneckere & Carl Davidson, 1985. "Incentives to Form Coalitions with Bertrand Competition," RAND Journal of Economics, The RAND Corporation, vol. 16(4), pages 473-486, Winter.
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