Financial market-product market interactions in industry equilibrium: Implications for information acquisition decisions

Abstract

With few exceptions, theories of optimal capital structure have been derived for single firms in isolation. ’ This approach does not model the effect of a capital structure decision on other firms in the industry and can therefore not take into account industry equilibrium conditions. Recently, first steps towards an analysis of capital structure decisions in an industry equilibrium have been made. These contributions demonstrate that in this setting some standard results of single firm capital structure theories may be reversed. Modelling the decisions of other firms is particularly important when analysing the effect of capital structure on product market decisions since the product market effects depend crucially on a firm’s competitive environment. The emerging literature on financial market-product market interactions in industry equilibrium can be classified into a strand of literature which uses capital structure as a commitment device and one in which capital structure does not play such a role. The former models rely on the fact that rival firms can observe the choice of capital structure and rationally anticipate its effects on subsequent investment and production decisions. The latter models do not require a commitment effect of capital structure. In these contributions, firms have no incentive to alter their capital structures in equilibrium, even if capital structure renegotiations were unobservable.