Financing Decisions and Advertising: An Empirical Study of Capital Structure and Product Market Competition
44 Pages Posted: 18 Jun 2002
Date Written: May 10, 2002
We study how a firm's financial structure affects the intensity with which it competes in the product market. Using a sample of firms that raise significant amounts of capital, we study the extent of their non-price competition, as measured by their advertising expenditures, following this event. We find that after controlling for other factors, firms whose financial leverage has decreased as a result of the new funding increase their advertising competition significantly more than firms whose leverage has increased. We undertake both an instrumental variables approach and a "reverse causality" test to address the issue of the endogeneity of the capital structure and advertising decisions and show that it is indeed capital structure changes that influence the degree of advertising competition. We also find that the reaction of the sample firms' industry rivals is influenced as well by their capital structures. Specifically, we find that a rival firm responds more (less) aggressively - relative to its' peers - in the increase of its' own advertising, if it is less (more) levered than the sample firm in its' industry that has initiated the more intense advertising competition. Overall, our results support the view that financial leverage appears to have a "dampening" effect on the intensity with which a firm chooses to compete in the product market.
JEL Classification: G32
Suggested Citation: Suggested Citation