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 Dou

Winston Dou

The Wharton School, University of Pennsylvania

Yan Ji

Hong Kong University of Science & Technology (HKUST)

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

Dou, Winston 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

Winston Dou (Contact Author)

The Wharton School, University of Pennsylvania ( email )

2318 Steinberg Hall - Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States

Yan Ji

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

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