Feedback and Contagion through Distressed Competition

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

Jacobs Levy Equity Management Center for Quantitative Financial Research Paper

61 Pages Posted: 5 Feb 2020 Last revised: 10 Jan 2023

See all articles by Hui Chen

Hui Chen

Massachusetts Institute of Technology

Winston Wei Dou

The Wharton School, University of Pennsylvania; National Bureau of Economic Research (NBER)

Hongye Guo

University of Pennsylvania

Yan Ji

Hong Kong University of Science & Technology (HKUST)

Multiple version iconThere are 2 versions of this paper

Date Written: December 31, 2022

Abstract

Firms tend to compete more aggressively in financial distress; the intensified competition in turn reduces profit margins, pushing themselves further into distress and adversely affecting other firms. To study such feedback and contagion effects, we incorporate strategic competition into a dynamic model with long-term defaultable debt, which generates various peer interactions like predation and self-defense. The feedback effect imposes an additional source of financial distress costs incurred for raising leverage, which helps explain the negative profitability-leverage relation across industries. Owing to the contagion effect, in a decentralized equilibrium, leverage is excessively high from an industry perspective, compromising industry's financial stability.

Keywords: Competition-distress feedback loop, Distress spillover, Predatory price war, Profitability-leverage puzzle, Tacit collusion

JEL Classification: C73, D43, E31, G3, L13, O33

Suggested Citation

Chen, Hui and Dou, Winston Wei and Guo, Hongye and Ji, Yan, Feedback and Contagion through Distressed Competition (December 31, 2022). The Rodney L. White Center Working Papers Series at the Wharton School, Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=3513296 or http://dx.doi.org/10.2139/ssrn.3513296

Hui Chen

Massachusetts Institute of Technology ( email )

50 Memorial Drive
Cambridge, MA 02142
United States
+1 (617) 324-3896 (Phone)

Winston Wei Dou (Contact Author)

The Wharton School, University of Pennsylvania ( email )

2318 Steinberg Hall - Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States

HOME PAGE: http://finance-faculty.wharton.upenn.edu/wdou/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://www.nber.org/people/winston_wei_dou?page=1&perPage=50

Hongye Guo

University of Pennsylvania ( email )

Yan Ji

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
869
Abstract Views
4,583
Rank
41,974
PlumX Metrics