Debt as a (Credible) Collusive Device

Abstract:     
The paper presents a theory of the anti-competitive effects of debt finance based on the interaction between capital structure, managerial incentives, and firms' ability to sustain collusive agreements. It shows that shareholders' commitments that reduce conflicts with debtholders - such as hiring managers with valuable reputations or "conservative" incentives - besides reducing the agency costs of debt finance also greatly facilitate tacit collusion in product markets. Concentrated or collusive credit markets, interlinked banking groups, or simply large banks can ensure the credibility of such commitments (renegotiation-proofness), thereby "exporting" collusion through leverage in otherwise competitive downstream product markets. The results appear relevant to the debate on the relative efficiency of "Anglo-Saxon" vs. "Continental-Japanese" financial practices. Implications for competition policy in the credit market and the regulation of the banking industry are discussed.

JEL Classifications: D43, G20, G30, L13, L41

Working Paper Series