SFB 303 Discussion Paper No. A - 211

Author: Broeker, Thorsten
Title: On the Strategic Relevance of the Financial Structure of Firms in a Two-Period Cournot Duopoly
Abstract: In this paper, we analyze the strategic relevance of the financial structure of a firm when it is engaged in oligopolistic competition over time. Specifically, we consider a two-period Cournot duopoly. Before a firm can enter the market, it has to pay some set-up cost. A firm can raise the funds needed by demanding debt or equity financing on a capital market. At the end of period one, first shareholders and then creditors of a firm are allowed to decide whether or not to liquidate the firm. The creditors’ right to liquidate a firm is linked to the disability of the firm to meet its repayment obligations in this period. Being able to move first gives the shareholders of a firm a strategic advantage over the creditors of the other firm. A firm may now be able to force its competitor be declared bankrupt by the creditors of the latter firm. It may be profitable to force its competitor out of the market, because now the firm will receive monopoly profit in the second period of the game. Due to the fact that the flow of gross profits of a firm does depend on its financial structure, we obtain two results: first, the value of a firm depends on the financial structure of both firms and therefore the Modigliani-Miller Theorem does not hold, and second, if we include the financial market into the game, then, depending on the subgame perfect continuation of the game, certain financial structures will not occur as an equilibrium of the capital market.
Creation-Date: November 1988
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