DP2049 Inside versus Outside Financing and Product Market Competition

Author(s): Monika Schnitzer, Achim Wambach
Publication Date: December 1998
Keyword(s): Bertrand Competition, Corporate Finance, impact of financial Structure on competition, impact of product competition on financial structure, inside versus outside financing
JEL(s): D43, G32, L13, L22
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2049

This paper investigates the interaction of firms' financial structure and their competitive behaviour on oligopolistic product markets. We consider risk-averse entrepreneurs who produce with uncertain production costs. To reduce their exposure to risk they can sell stocks to risk-neutral outside-investors. We show that in equilibrium the entrepreneurs prefer not to fully transfer this risk to outside-financiers because it reduces the competitive pressure on the product market. Furthermore, we discuss how the optimal financial structure reacts to variations in entrepreneurs' risk aversion, the level of cost uncertainty and the number of competitors.