External Financing and Customer Capital: A Financial Theory of Markups

Dou, Winston Wei; Ji, Yan

doi:10.2139/ssrn.2574953

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External Financing and Customer Capital: A Financial Theory of Markups

Management Science, Forthcoming

49 Pages Posted: 8 Mar 2015 Last revised: 12 May 2020

See all articles by Winston Wei Dou

Winston Wei Dou

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Yan Ji

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Date Written: May 9, 2020

Abstract

We develop a continuous-time industry equilibrium model of monopolistic competition to understand how product markups are determined in the presence of external financing costs and customer capital. Firms optimally set markups to balance the tradeoff between profiting from their existing customer base and developing their future customer base. We characterize how the equilibrium markups are determined by the interaction between the marginal value of corporate liquidity and the marginal value of customer base. Firms' markups are more responsive to changes in their marginal value of corporate liquidity when the marginal value of customer base is higher. Moreover, the model predicts that greater product market threats lead to more conservative financial policies, which is supported by the data.

Keywords: Markups, Customer base, External financing costs, Monopolistic competition, Corporate liquidity, Industry dynamics.

JEL Classification: E31, G32, G35, L13

Suggested Citation: Suggested Citation

Dou, Winston Wei and Ji, Yan, External Financing and Customer Capital: A Financial Theory of Markups (May 9, 2020). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2574953 or http://dx.doi.org/10.2139/ssrn.2574953