Abstract
In a seminal paper Brander and Lewis (Am Econ Rev 76:956–970, 1986) show that oligopolistic firms with limited liability follow a more aggressive output strategy as their leverage increases. In a follow-up paper Glazer (J Econ Theory 62:428–443, 1994) points out that when debt is long term and rival firms choose their equilibrium quantities in two consecutive periods, they have an incentive to be more collusive in the first period than static oligopolists would be. In this paper we argue that the incentive to collude is driven by limited liability and the dividend policy of the firm. We find that increasing leverage causes firms in both periods to increase their output and hence to be more aggressive. Additionally, we find that it is always optimal to pay out profits immediately. Moreover, we show that the symmetric game admits multiple equilibria some of which cause firms to choose asymmetric product market strategies.
Highlights
Beginning with the seminal paper of Brander and Lewis [3] a whole strand of the literature has shown that there are important linkages between financial structure and product marketEngelbert J
In this paper we analyze the effects of dividend payments on the product market behavior of firms if markets are oligopolistic and firms issue debt
It turns out that it is not the nature of debt that plays a crucial role for the equilibrium outputs in the two periods but the way profits earned in the first period are distributed to the shareholders
Summary
Beginning with the seminal paper of Brander and Lewis [3] a whole strand of the literature has shown that there are important linkages between financial structure and product market. While the theory initiated by Brander and Lewis emphasizes the linkages between the product and financial markets, Glazer [11] challenges their prediction that debt always results in more aggressive output market behavior He considers the case in which firms face a two-period Cournot game where they choose output in each period, while debt is long term and is fully repaid only at the end of the second period when the demand uncertainty is resolved. We show by means of a numerical example that the dynamic symmetric game admits asymmetric subgame-perfect equilibria This observation leads us to conclude that firms which face similar demand characteristics and financial structure may very well end up with very different output market strategies.
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