Does a Cash Squeeze Affect Competitive Outcomes of Firms and Their Rivals?

Abstract

Using a tax-induced negative shock to expected cash flows in the tobacco industry as a natural experiment, I find significant positive returns to rivals who compete with non-tobacco segments in tobacco firms and a significant change in output behavior of those non-tobacco segments after the shock. This suggests that a firm's cash flow has an important effect on its competitive outcomes in the product market. The effects are robust to a number of estimation issues and identification choices. Since the shock is exogenous to the investment opportunities of non-tobacco industries, my evidence supports the hypothesis that there is a causal relation between a firm's cash flow and its product market behavior. Moreover, I find that the connection between cash flow and competitive performance is magnified in competitive industries and when cash-constrained firms only have a small market share.