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Debt, investment, and product market competition: A note on the limited liability effect

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  • Clayton, Matthew J.

Abstract

This paper extends a model by Brander and Lewis [Brander, J., Lewis, T., 1986. Oligopoly and financial structure: The limited liability effect. American Economic Review 76, 956-970] on the relationship between capital structure, investment and product market competition based on the limited liability effect of debt. Empirical papers (see for example Campello [Campello, M., 2003. Capital structure and product markets interactions: Evidence from business cycles. Journal of Financial Economics 68, 353-378], and Chevalier [Chevalier, J., 1995a. Capital structure and product market competition: Empirical evidence from the supermarket industry. American Economic Review 85, 415-435; Chevalier, J., 1995b. Do LBO supermarkets charge more? An empirical analysis of the effect of LBOs on supermarket pricing. Journal of Finance 50, 1095-1112]) generally reject the limited liability theories in favor of the predatory theories because leverage leads to less investment and weaker product market competition. This paper shows that when firms also have an investment choice, leverage can lead to weaker product market competition in a limited liability model. In addition, non-zero leverage is still optimal within this model based solely on the limited liability effect. In predatory models debt is motivated by issues outside of product market concerns, for example to solve an agency problem. Finally, this model is also consistent with the investment decisions documented empirically.

Suggested Citation

  • Clayton, Matthew J., 2009. "Debt, investment, and product market competition: A note on the limited liability effect," Journal of Banking & Finance, Elsevier, vol. 33(4), pages 694-700, April.
    • Handle: RePEc:eee:jbfina:v:33:y:2009:i:4:p:694-700
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    References listed on IDEAS

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    1. Matthew J. Clayton & Bjorn N. Jorgensen, 2005. "Optimal Cross Holding with Externalities and Strategic Interactions," The Journal of Business, University of Chicago Press, vol. 78(4), pages 1505-1522, July.
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    5. Brander, James A. & Lewis, Tracy R., 1986. "Oligopoly and Financial Structure: The Limited Liability Effect," American Economic Review, American Economic Association, vol. 76(5), pages 956-970, December.
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    11. Campello, Murillo, 2003. "Capital structure and product markets interactions: evidence from business cycles," Journal of Financial Economics, Elsevier, vol. 68(3), pages 353-378, June.
    12. Matthew J. Clayton & S. Abraham Ravid, 2002. "The Effect of Leverage on Bidding Behavior: Theory and Evidence from the FCC Auctions," The Review of Financial Studies, Society for Financial Studies, vol. 15(3), pages 723-750.
    13. Rotemberg, Julio J & Scharfstein, David S, 1990. "Shareholder-Value Maximization and Product-Market Competition," The Review of Financial Studies, Society for Financial Studies, vol. 3(3), pages 367-391.
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    Cited by:

    1. Bernini, Michele & Guillou, Sarah & Bellone, Flora, 2015. "Financial leverage and export quality: Evidence from France," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 280-296.
    2. repec:hal:spmain:info:hdl:2441/14bcgn3ce19ns9gv417qkp04in is not listed on IDEAS
    3. Akdoğu, Evrim & MacKay, Peter, 2012. "Product markets and corporate investment: Theory and evidence," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 439-453.
    4. Jiaqi Qin & Yan Sun, 2023. "Unveil the veil of limited liability: Evidence from firm investment," The Financial Review, Eastern Finance Association, vol. 58(3), pages 485-511, August.
    5. Ernesto Lopez‐Valeiras & Jacobo Gomez‐Conde & Teresa Fernandez‐Rodriguez, 2016. "Firm Size and Financial Performance: Intermediate Effects of Indebtedness," Agribusiness, John Wiley & Sons, Ltd., vol. 32(4), pages 454-465, November.
    6. Kayo, Eduardo K. & Kimura, Herbert, 2011. "Hierarchical determinants of capital structure," Journal of Banking & Finance, Elsevier, vol. 35(2), pages 358-371, February.
    7. Flora Bellone & Michel Bernini & Sarah Guillou, 2015. "Financial leverage and export quality: evidence from France," Post-Print hal-03470073, HAL.
    8. repec:spo:wpmain:info:hdl:2441/14bcgn3ce19ns9gv417qkp04in is not listed on IDEAS
    9. David C. Mauer & Natalia Villatoro & Yilei Zhang, 2022. "Brand equity and corporate debt structure," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 49(7-8), pages 1077-1112, July.
    10. Flora Bellone & Michel Bernini & Sarah Guillou, 2015. "Financial leverage and export quality: evidence from France," SciencePo Working papers Main hal-03470073, HAL.
    11. Clayton, Matthew J. & Jorgensen, Bjorn N., 2011. "Corporate equity ownership, investment, and product market relationships," Journal of Corporate Finance, Elsevier, vol. 17(5), pages 1377-1388.

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