Abstract
We develop a model of Bertrand competition in differentiated products, in order to examine the relationship between product market competition and financial leverage. Leverage softens price competition by inducing firms to discount the future more heavily. We consider potential intensity and actual intensity of competition. Increasing the potential intensity of competition may motivate the firm to increase leverage in order to soften price competition. However, the combination of increasing potential intensity and increasing leverage may actually result in prices and firm values falling. Therefore, increasing leverage may appear to toughen price competition, when, in fact, it weakens it.
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