Predatory Advertising, Financial Fraud, and Leverage

62 Pages Posted: 8 Dec 2019 Last revised: 10 Feb 2020

See all articles by Shantanu Banerjee

Shantanu Banerjee

Lancaster University - Management School

Sudipto Dasgupta

Chinese University of Hong Kong, ABFER, CEPR, and ECGI

Rui Shi

Lancaster University - Lancaster University Management School

Jiali Yan

University of Liverpool - Management School (ULMS)

Date Written: November 18, 2019

Abstract

We examine how an industry leader’s competitors respond when financial fraud by the leader is publicly revealed. We document evidence of predatory advertising and pricing. Close competitors of the leader step up advertisement spending relative to control firms. Although we do not directly observe product prices, we find that even though advertisement increases, competitors’ profit margins drop, consistent with predatory pricing. Evidence of predation is stronger when rival firms have larger market share, the fraud firm has higher leverage, and when the average leverage of rival firms is lower. The effects appear mainly in industries that produce customized products and where consumer switching costs are high. Increasing advertising expenditure appears to be a more potent predatory strategy in industries that experience new customer growth, whereas cutting prices appears more potent in industries with stagnant customer base. We present a switching cost model similar to Klemperer (1995) that generates implications broadly consistent with these observations.

Keywords: predatory advertising; financial misconduct; leverage; product pricing strategy

JEL Classification: G13, M37

Suggested Citation

Banerjee, Shantanu and Dasgupta, Sudipto and SHI, RUI and Yan, Jiali, Predatory Advertising, Financial Fraud, and Leverage (November 18, 2019). Available at SSRN: https://ssrn.com/abstract=3488979 or http://dx.doi.org/10.2139/ssrn.3488979

Shantanu Banerjee

Lancaster University - Management School ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

Sudipto Dasgupta (Contact Author)

Chinese University of Hong Kong, ABFER, CEPR, and ECGI ( email )

CUHK, Cheng Yu Tung Building, Room 1224
Shatin, NT
Hong Kong
Hong Kong

RUI SHI

Lancaster University - Lancaster University Management School ( email )

Economics Department,
LUMS,
Bailrigg Lancaster, LA1 4YX
United Kingdom

Jiali Yan

University of Liverpool - Management School (ULMS) ( email )

Chatham Street
Liverpool, L69 7ZH
United Kingdom

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