Capital Structure, Product Market Dynamics, and the Boundaries of the Firm

52 Pages Posted: 23 Feb 2011 Last revised: 30 May 2014

See all articles by Dirk Hackbarth

Dirk Hackbarth

Boston University - Questrom School of Business; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Richmond D. Mathews

University of Maryland - Department of Finance

David T. Robinson

Fuqua School of Business, Duke University; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative

Date Written: July 2, 2012

Abstract

We study how interactions between financing and investment decisions can shape firm boundaries in dynamic product markets. In particular, we model a new product market opportunity as a growth option and ask whether it is best exploited by a large incumbent firm (Integration) or by a separate, specialized firm (Non-Integration). Starting from a standard theoretical framework, in which value-maximizing corporate investment and financing decisions are jointly determined, we show that Integration best protects assets in place value, while Non-Integration best protects the value of the growth option and maximizes financial flexibility. These forces drive different organizational equilibria depending on firm and product market characteristics. In particular, we show that increases in standard measures of cash flow risk predict exploitation of new opportunities by specialized firms, while increases in product market risk (i.e., the risk of preemption by competitors) predict exploitation by incumbents. We also show that alliances organized as licensing agreements or revenue sharing contracts sometimes better balance the different sources of value, and thus may dominate more traditional forms of organization. These key results arise from the dynamic interaction of the new opportunity’s option-like features with realistic competitive forces.

The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2443868

Keywords: capital structure, corporate investment, organizational design, real options

JEL Classification: G13, G31, G32, G33

Suggested Citation

Hackbarth, Dirk and Mathews, Richmond D. and Robinson, David T., Capital Structure, Product Market Dynamics, and the Boundaries of the Firm (July 2, 2012). AFA 2012 Chicago Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1767483 or http://dx.doi.org/10.2139/ssrn.1767483

Dirk Hackbarth (Contact Author)

Boston University - Questrom School of Business ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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European Corporate Governance Institute (ECGI) ( email )

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Richmond D. Mathews

University of Maryland - Department of Finance ( email )

Robert H. Smith School of Business
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David T. Robinson

Fuqua School of Business, Duke University ( email )

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National Bureau of Economic Research (NBER) ( email )

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Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
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