On the Strategic Use of Debt and Capacity in Imperfectly Competitive; Product Markets
Scholarly Edition
Overview
abstract
In capital intensive industries, firms face complicated; multi-stage financing, investment, and production decisions under the ; watchful eye of existing and potential industry rivals. We consider a ; two-stage simplification of this environment. In the first stage, an ; incumbent firm benefits from two first-mover advantages by precommiting ; to a debt financing policy and a capacity investment policy. In the ; second stage, the incumbent and a single-stage rival simultaneously ; choose production levels and realize stochastic profits. We ; characterize the incumbent's first-stage debt and capacity choices as ; factors in the production of an intermediate good we call "output ; deterrence." In our two-factor deterrence model, we show that the ; incumbent chooses a unique capacity policy and a threshold debt policy ; to achieve the optimal level of deterrence coinciding with full ; Stackelberg leadership. When we remove the incumbent's first-mover ; advantage in capacity, the full Stackelberg level of deterrence is ; still achievable, albeit with a higher level of debt than the ; threshold. In contrast, when we remove the incumbent's first-mover ; advantage in debt, the Stackelberg level of deterrence may no longer be ; achievable and the incumbent may suffer a dead-weight loss. Evidence on ; the telecommunications industry shows that firms have increased their ; leverage in a manner consistent with deterring potential rivals ; following the 1996 deregulation.
