Competition and the Cost of Debt

Abstract

This paper empirically shows that the cost of bank debt is systematically higher for firms that operate in competitive product markets. Using various proxies for product market competition, and reductions of import tariffs to capture exogenous changes to a firm’s competitive environment, I find that competition has a significantly positive effect on the cost of bank debt. Moreover, the analysis reveals that the effect of competition is greater in industries in which firms face financially strong rivals, a high intensity of strategic interactions, and in industries with illiquid and specific assets. Overall, these findings suggest that banks price financial contracts by taking into account the risk that arises from product market competition.

Keywords: Product Market Competition, Financing Costs, Debt Financing, Financial Contracts, Industry Structure

JEL Classification: G32, G34