A New Firm Entry Under Capital Constraint

Abstract

This study examines whether and how an entrant (she) can enter a market with a dominant incumbent (he), when they both are capital constrained and need to borrow loans from the credit market. While in a perfectly competitive credit market, the success of the entrant depends on her target on reserved return on investment (RROI), in a monopolistic credit market, it depends on the working capital level of the entrant as well. Interestingly, it is not always advantageous for the entrant to prepare a medium level of working capital because it may not be sufficient for the entrant to meet her RROI target, and at the same time it may disincentivize the bank to offer her loans due to the insufficient loan demand. That is, the monopoly credit market denies the entrant, who may enter the market in a competitive credit market. However, with a sufficient amount of working capital, the entrant will fail to enter in a competitive credit market but succeed in a monopolistic credit market given a certain rang of RROI target. This is because banking competition may erode the entrant’s financial competitiveness, which can be strengthened under banking monopoly. Our work presents a unified explanation for the conflicting empirical findings in finance literature on which type of the credit market, competitive vs. monopolistic, facilitates the entrant’s successful entry. Furthermore, the entrant can access the market in both credit markets under certain circumstances, where she is better off in the monopolistic financial environment if her RROI target is low and her working capital amount is sufficient, otherwise in the competitive financial environment.

Keywords: market entry; deterrence; capital constraint; bank credit