Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 243: Debt as a (Credible) Collusive Device, or: "Everybody Happy but the Consumer"

Giancarlo Spagnolo ()
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Giancarlo Spagnolo: Dept. of Economics, Stockholm School of Economics, Postal: P.O. Box 6501, SE-113 83 Stockholm, Sweden

Abstract: The paper proposes a theory of the anti-competitive effects of debt finance based on the interaction between capital structure, managerial incentives, and firms' ability to sustain collusive agreements. It shows that shareholders' commitments that reduce conflicts with debtholders - such as hiring managers with valuable reputations or "conservative" incentives - besides reducing the agency costs of debt finance also greatly facilitate tacit collusion in product markets. Concentrated or collusive credit markets, or large banking groups, can ensure the credibility of such commitments (renegotiation-proofness), thereby "exporting" collusion through leverage in otherwise competitive downstream product markets.

Keywords: Banks; oligopoly; financial market - product market interaction; capital structure; managerial incentives; collusion; governance.

JEL-codes: D21; G32; L13; L41

47 pages, First version: June 8, 1998. Revised: August 1, 2004. Earlier revisions: November 10, 1998, November 29, 1998, September 12, 1999, November 30, 1999, May 18, 2000, November 8, 2004.

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