Product Market Performance, Switching Costs, and Liquidation Values: The Real Effects of Financial Leverage
43 Pages Posted: 19 Mar 2005
Date Written: March 2006
Abstract
We model the interaction of product market competition and firms' financing decision when firms face capital market imperfections and consumers face switching costs. In our model, consumers anticipate that capital market frictions may drive their supplier out of business and account for welfare losses that firm bankruptcy imposes upon them. Likewise, managers, when investing in long-term market share building, take into account the possibility of business failure and the residual value they may capture from the firm's liquidation process. Our theory yields four central implications. In response to a negative shock to demand: (1) more leveraged firms will experience significant market share losses; (2) the market share losses of more leveraged firms will be more pronounced in industries where low debt usage is the norm; (3) the market share losses of more leveraged firms will be more pronounced in industries where consumers face higher switching costs; and (4) the market share losses of more leveraged firms will be magnified in industries where asset liquidation is less efficient. Using detailed firm- and industry-level data from U.S. manufacturers over the 1990-91 recession, we present empirical evidence supporting our model's predictions. We later expand our empirical analysis, studying a large panel of firms over the various phases of the full business cycles contained in the 1976-96 period. Results from these broader tests provide additional evidence in support of our theory.
Keywords: Leverage, product market competition, switching costs, asset liquidation, endogeneity, business cycles
JEL Classification: G32, D43, E32
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Capital Market Imperfections and Countercyclical Markups: Theory and Evidence
-
Survival of the Fittest or the Fattest? Exit and Financing in the Trucking Industry
-
Survival of the Fittest or the Fattest? Exit and Financing in the Trucking Industry
-
Capital Structure and Product Markets Interactions: Evidence from Business Cycles
-
Debt Financing: Does it Boost or Hurt Firm Performance in Product Markets?
-
Pricing Strategy and Financial Policy
By Sudipto Dasgupta and Sheridan Titman
-
Capital Structure as a Strategic Variable: Evidence from Collective Bargaining
-
By Ashiq Ali, Sandy Klasa, ...
-
Corporate Capital Structure and the Characteristics of Suppliers and Customers
By Jayant R. Kale and Husayn K. Shahrur
-
Capital Structure and Interaction Among Firms in Output Markets - Theory and Evidence