Competition Shocks, Rival Reactions, and Stock Return Comovement

Abstract

To protect inframarginal rents, rivals react to competition shocks by increasing product differentiation or lowering costs by standardizing products and production processes. We test these two mutually exclusive reactions by exploiting changes in rivals' idiosyncratic stock return comovement following significant tariff cuts. While increased product differentiation implies a reduction in return comovement, greater standardization implies the opposite (a comovement increase). Difference-in-differences tests indicate that tariff cuts cause a significant increase in return comovement - in particular among within-industry ``followers''. Treatment effects on cash flows, product counts, similarity scores, and business-segment counts further support cost-cutting strategies..

Keywords: Return co-movement, competitive shocks, rival reactions, differentiation, M&As

JEL Classification: G34, G38, L10, L25