SIFR Research Report Series,
Institute for Financial Research

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.

Keywords: Industrial organization; Deregulation; Deterrence; Capital structure; Capacity; Telecommunications

JEL-codes: D43; G32; L13; L96

52 pages, March 15, 2004

Full text files

sifr-wp33.pdf  

Download statistics

• Institute for Financial Research
• Home page for this series

Questions (including download problems) about the papers in this series should be directed to Anki Helmer ()
Report other problems with accessing this service to Sune Karlsson ().

This page generated on 2024-02-05 17:13:34.