Dynamic Competition, Valuation and Merger Activity

Abstract

We model the interactions between product market competition and investment valuation within a dynamic oligopoly. It is, to our knowledge, the first continuous time corporate finance model in a multiple firm setting with heterogeneous products. The model is tractable and amenable to estimation. We use it to relate current industry characteristics with firm value and financial decisions. Unlike most corporate finance models, it produces predictions regarding parameter magnitudes as well their sign. Estimates of the model’s parameters indicate strong linkages between model-implied and actual values. The paper uses the estimated parameters to predict rivals’ returns near merger announcements.