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The strategic effect of debt in dynamic price competition with fluctuating demand

  • Neubecker, Leslie
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    This paper shows that obligations from debt hinder tacit collusion if equity owners are protected by limited liability. In contrast to its advantageous commitment value in short-run competition, leverage reduces profits from infinite interaction. Contrasting uncorrelated shocks with a cyclical demand development, we show that in the first case optimal pricing is anticyclical. With demand cycles, it is anticyclical only if equity holders place a low value on future profits, but procyclical otherwise. In both cases, the cyclicity of prices increases with the debt level. Contrary to traditional wisdom, a lower degree of homogeneity may raise profits of leveraged firms.

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    Paper provided by University of Tübingen, School of Business and Economics in its series Tübinger Diskussionsbeiträge with number 250.

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    Date of creation: 2002
    Date of revision:
    Handle: RePEc:zbw:tuedps:250
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    1. Chevalier, Judith A & Scharfstein, David S, 1996. "Capital-Market Imperfections and Countercyclical Markups: Theory and Evidence," American Economic Review, American Economic Association, vol. 86(4), pages 703-25, September.
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    11. Michael L. Katz., 1991. "Game-Playing Agents: Unobservable Contracts as Precommitments," Economics Working Papers 91-172, University of California at Berkeley.
    12. Showalter, Dean M, 1995. "Oligopoly and Financial Structure: Comment," American Economic Review, American Economic Association, vol. 85(3), pages 647-53, June.
    13. Wanzenried, Gabrielle, 2003. "Capital structure decisions and output market competition under demand uncertainty," International Journal of Industrial Organization, Elsevier, vol. 21(2), pages 171-200, February.
    14. James A. Brander & Tracy R. Lewis, 1988. "Bankruptcy Costs and the Theory of Oligopoly," Canadian Journal of Economics, Canadian Economics Association, vol. 21(2), pages 221-43, May.
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    16. Stenbacka, Rune, 1994. "Financial structure and tacit collusion with repeated oligopoly competition," Journal of Economic Behavior & Organization, Elsevier, vol. 25(2), pages 281-292, October.
    17. Dick Damania, 1997. "Debt as a collusive device in an oligopoly supergame," Journal of Economics, Springer, vol. 66(3), pages 249-269, October.
    18. Zwiebel, Jeffrey, 1996. "Dynamic Capital Structure under Managerial Entrenchment," American Economic Review, American Economic Association, vol. 86(5), pages 1197-1215, December.
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