Bank-Firm Relationship as a Strategic Commitment in a Duopolistic Environment

Abstract

By using a three-stage game, this paper shows that an investment in the banking sector may commit a duopolistic firm to a more aggressive output stance. This aggressiveness is translated by an outward shift in the firm's reaction function, thus increasing its own output and decreasing its rival's output. While it is individually beneficial for a firm to invest in a banking business, both firms taken together in a duopoly industry are made worse-off by such an investment, because they produce too much. Firms are caught in a financial version of the prisoner's dilemma.