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On the Impact of Financial Structure on Product Selection

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Abstract

We examine the interaction between financial and microeconomic decisions in a differentiated duopoly under uncertainty as to consumer taste for quality. Financing is by equity and debt and product specification is endogenous. We consider two three-stage games, according to the order of moves: qualities-financial structure-prices and financial structure-qualities-prices. Once debt is contracted, the manager maximizes equity instead of total value. We find that in both games debt a) increases both prices and qualities but most likely reduces product differentiation due to rival quality response; b) reduces the value of the levered high quality firm because it increases the low quality. Moreover, c) the cost of debt is higher for the second game, implying that it is higher for projects using debt to finance a product’s development-cum-commercialization compared to those financing only the commercialization stage. The results turn out to be robust to alternative specifications of quality and market size uncertainty.

Suggested Citation

  • Christos Constantatos & Stylianos Perrakis, 2010. "On the Impact of Financial Structure on Product Selection," Discussion Paper Series 2010_11, Department of Economics, University of Macedonia, revised Nov 2010.
    • Handle: RePEc:mcd:mcddps:2010_11
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    More about this item

    Keywords

    Vertical differentiation; uncertainty; financial structure; leverage; sequential quality choice.;
    All these keywords.

    JEL classification:

    • L00 - Industrial Organization - - General - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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