On Financial Frictions and Firm Market Power

42 Pages Posted: 9 Aug 2019

See all articles by Miguel Casares

Miguel Casares

Universidad Pública de Navarra

Jose E. Galdon-Sanchez

Universidad Publica de Navarra ; IZA

Luca Deidda

Università degli Studi di Sassari

Date Written: August 9, 2019

Abstract

We build a static general-equilibrium model with monopolistically competitive firms that borrow funds from competitive banks in an economy subject to financial frictions. These frictions are due to non verifiability of both ex post firm returns and managerial effort. Market power has opposing effects. On one side, firms’ pricing over marginal cost reduces output compared to perfect competition. On the other, by increasing firms’ profitability, market power reduces the impact of financial frictions. The resulting tradeoff is ambiguous. We show that, other things equal, there exists an optimal positive level of market power that maximizes welfare. Such optimal degree of market power increases with moral hazard and decreases with the efficiency of firm liquidation following bankruptcy.

Keywords: market power, moral hazard, bankruptcy, liquidation

JEL Classification: E44, G21, G33

Suggested Citation

Casares, Miguel and Galdon-Sanchez, Jose E. and Deidda, Luca, On Financial Frictions and Firm Market Power (August 9, 2019). Banco de Espana Working Paper No. 1929 (2019). Available at SSRN: https://ssrn.com/abstract=3434946 or http://dx.doi.org/10.2139/ssrn.3434946

Miguel Casares (Contact Author)

Universidad Pública de Navarra ( email )

Departamento de Economía
31006 Pamplona
Spain

Jose E. Galdon-Sanchez

Universidad Publica de Navarra ( email )

Department of Economics
Campus de Arrosadia
Pamplona, Navarra 31006
Spain
+34 948 16 9338 (Phone)
+34 948 16 97 21 (Fax)

HOME PAGE: http://www.econ.unavarra.es/~galdon/

IZA

P.O. Box 7240
Bonn, D-53072
Germany

HOME PAGE: http://www.iza.org/en/webcontent/personnel/photos/index_html?key=1494

Luca Deidda

Università degli Studi di Sassari ( email )

Piazza Universita
Sassari, 07100
Italy

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