Financial Strength and Product Market Competition: Evidence from Asbestos Litigation

Abstract

We study the role of financial strength on product market competition by examining exogenous shocks to a firm's liability structure arising from asbestos litigation. We find that unexpected exogenous increases (decreases) in a firm's asbestos liabilities arising from actions by external parties are interpreted by the market as negative (positive) news for the firm's close competitors. Since asbestos liabilities are debt-like claims, these findings support the hypothesis that increases in fixed liabilities lead to more aggressive competitive interactions. Competitor returns are particularly negative in events in which one asbestos-tainted firm goes bankrupt and other asbestos stocks fall on the news, suggesting that non-equity liabilities affect a firm's product market decisions by causing them to discount default states of the world. The magnitude of the response of competitor stocks to asbestos liability shocks is not related to most of the firm and industry characteristics we consider, casting doubt on some possible explanations for our findings.

Keywords: financial strength, debt, product market competition, asbestos liabilities

JEL Classification: G32, L13