Predatory Pricing and the Value of Corporate Cash Holdings

Abstract

We analyze the interaction between firms' payout policies and their decisions in product markets in a continuous-time stochastic game between two firms. One of these is financially constrained, whereas the other is not. Contrary to the standard literature we allow firms to choose production and payout strategies, and focus on the effect of predation incentives on both. We find that predation induces fewer dividend payouts. Furthermore, the liquidity position of the constrained firm has an economically significant effect on the production choices of both firms and, thus, on the evolution of profits, cash holdings and stock returns.