Debt as an Entry Deterrent under Bertrand Price Competition

Abstract

In recent studies of strategic debt little attention has been paid to the use of debt in deterring potential rivals. I show that in a Bertrand-type industry where costs are uncertain, an incumbent monopolist can deter entry by using debt to commit to a sufficiently low price. If demand is uncertain, deterrence is not possible, and an incumbent will choose positive debt levels to induce 'softer' post-entry competition. The results under demand uncertainty support recent empirical evidence that leverage is negatively associated with output and positively associated with prices.