Feedback and Contagion through Distressed Competition

Journal of Finance

60 Pages Posted: 5 Feb 2020 Last revised: 9 Jan 2024

See all articles by Hui Chen

Hui Chen

Massachusetts Institute of Technology

Winston Wei Dou

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

Hongye Guo

The University of Hong Kong - University of Hong Kong

Yan Ji

Hong Kong University of Science & Technology (HKUST)

Multiple version iconThere are 2 versions of this paper

Date Written: August 17, 2023

Abstract

Firms tend to compete more aggressively in financial distress; this intensified competition, in turn, reduces profit margins, pushing themselves further into distress and adversely affecting their industry peers. To study such feedback and contagion effects, we incorporate strategic competition into a dynamic model with long-term defaultable debt, exploring various peer interactions like predation and price war. The feedback effect represents a novel source of financial distress costs associated with leverage, which helps explain the negative profitability-leverage relation across industries. Owing to the contagion effect, firms’ optimal leverage is often excessively high from an industry perspective, undermining the industry's financial stability.

Keywords: Competition-distress feedback loop, Distress spillover, Predatory pricing, Price war, Profitability-leverage puzzle, 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 (August 17, 2023). Journal of Finance, 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)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
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HOME PAGE: http://www.nber.org/people/winston_wei_dou?page=1&perPage=50

Hongye Guo

The University of Hong Kong - University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Hong Kong
China

Yan Ji

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

Clearwater Bay
Kowloon, 999999
Hong Kong

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