Capital structure decisions and output market competition under demand uncertainty

Abstract

We consider a two-stage differentiated goods duopoly model with demand uncertainty linking firms’ capital structure choice with their output market decisions. The firms compete in quantities or prices on the market. We explain how firms’ capital structure depends on specific output market characteristics such as substitutability between products and demand volatility. We investigate whether strategic use of debt is able to mimic Stackelberg leadership. Finally, we consider the welfare effects of debt issue. This paper contributes to the understanding of the firms’ capital structure decisions, while specifically emphasizing the strategic use of debt. It investigates the relationships between firms’ output market and capital structure decisions with respect to specific demand and supply characteristics.