Industry Competition, Credit Spreads, and Levered Equity Returns

56 Pages Posted: 8 Jun 2017

See all articles by Alexandre Corhay

Alexandre Corhay

University of Toronto - Rotman School of Management

Date Written: June 1, 2017

Abstract

This paper examines the relation between industry competition, credit spreads, and levered equity returns. I build a quantitative model where firms make investment, financing, and default decisions subject to aggregate and idiosyncratic risk. Firms operate in heterogeneous industries that differ by the intensity of product market competition. Higher competition reduces profit opportunities and increases default risk for debtholders. Equityholders are protected against default risk due to the option value arising from limited liability. In equilibrium, competitive industries are characterized by higher credit spreads, but lower expected equity returns. I find strong empirical support for these predictions across concentration terciles.

Keywords: Strategic interactions, Capital structure, Default, Corporate bond credit spread, Equity premium, Recursive preferences

JEL Classification: G11, G12, G32, G33, E23, E32

Suggested Citation

Corhay, Alexandre, Industry Competition, Credit Spreads, and Levered Equity Returns (June 1, 2017). Rotman School of Management Working Paper No. 2981793, Available at SSRN: https://ssrn.com/abstract=2981793 or http://dx.doi.org/10.2139/ssrn.2981793

Alexandre Corhay (Contact Author)

University of Toronto - Rotman School of Management ( email )

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