High Discounts and High Competition

The Rodney L. White Center Working Papers Series at the Wharton School

The Jacobs Levy Equity Management Center for Quantitative Financial Research Working Papers Series

Mays Business School Research Paper

66 Pages Posted: 14 Jan 2019 Last revised: 19 Feb 2020

See all articles by Winston Dou

Winston Dou

The Wharton School, University of Pennsylvania

Yan Ji

Hong Kong University of Science & Technology (HKUST)

Wei Wu

Texas A&M University - Department of Finance

Date Written: February 18, 2020

Abstract

We build an industry equilibrium model with dynamic strategic competition to jointly explain the fluctuations in competition intensity, profitability, and asset prices. Product market competition endogenously intensifies as discount rates rise, because firms compete more aggressively for current cash flows by undercutting each other as the present value of future cooperation decreases. Competition intensity responds differently to aggregate discount rate shocks across different industries. In industries with a lower turnover rate of market leaders, firms' profit margins tend to be higher yet more exposed to discount rate fluctuations, thereby generating the gross profitability premium. We exploit exogenous variation in market structure --- large tariff cuts --- to test the model directly. Empirical evidence based on textual analysis also supports model implications.

Keywords: Product market friction, Oligopoly, Profitability premium, Leadership persistence, Tariff shocks

JEL Classification: G12, L13, O33, C73

Suggested Citation

Dou, Winston and Ji, Yan and Wu, Wei, High Discounts and High Competition (February 18, 2020). The Jacobs Levy Equity Management Center for Quantitative Financial Research Working Papers Series; Mays Business School Research Paper. Available at SSRN: https://ssrn.com/abstract=3309554 or http://dx.doi.org/10.2139/ssrn.3309554

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

Wei Wu

Texas A&M University - Department of Finance ( email )

360M Wehner
College Station, TX 77843-4218
United States
979-862-8092 (Phone)

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