Year of Graduation
Limited Liability Effects in Oligopolistic Competition
This study analyzes the linkage between firm debt level and firm behavior on the product market under oligopolistic competition.In the seminal Brander and Lewis article it was shown that firm can use debt as a commitment to be more aggressive in the product market due to the protection of limited liability. Brander and Lewis assumed products to be strategic compliments. The Increase in the debt level leads to the increase in the firm value due to limited liability in the following way. Increase in dept raises probability of bankruptcy; therefore choosing output firms consider only more favorable states of nature e.g. high demand states. And since it is optimal to increase output in more favorable states firms choose nonnegative debt level in the equilibrium.Brander and Lewis obtain this result assumed that if firms have zero debt, then they breakeven in the worst state of nature. But this assumption is restricting because if fixed cost of one firm is much lesser than others then ceteris paribus it would be solvent in the worst state of nature given other firms go bankrupt. Furthermore the exact shock level which provide unlevered firm solvency depends on the outputs of all firm in the industry.This study provides generalization of Brander and Lewis result for the case of arbitrary distributed stochastic shock. This generalization allows to analyze impact of change of the model’s parameters on the equilibrium debt levels. Future research on the influence of the debt seniority on strategic use of a certain type of debt in the model with several types of debt can be fulfilled on the analogy of the current study.It is shown in this study that under the broad assumptions increase in the firm marginal profit leads to the decrease in its debts level. This result provides rationale for some empirical results that were considered as contradiction to Brander-Lewis-Showalter theory before.