Predation or Self-Defense? Endogenous Competition and Financial Distress

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See all articles by Hui Chen

Hui Chen

Massachusetts Institute of Technology; National Bureau of Economic Research (NBER)

Winston Dou

The Wharton School, University of Pennsylvania

Hongye Guo

University of Pennsylvania

Yan Ji

Hong Kong University of Science & Technology (HKUST)

Date Written: January 3, 2020

Abstract

Firms tend to compete on prices more aggressively when they are in financial distress. The intensified competition in turn reduces firms' profit margins, pushing firms further into distress. To quantify the feedback effect between industry competition and financial distress and the predatory incentives, we incorporate supergames of price competition into a model of long-term debt and strategic default. We show that this feedback mechanism has important implications on asset prices and financial contagion. Depending on the heterogeneity in customer bases and financial conditions across firms in an industry as well as between incumbents and new entrants, firms can exhibit a rich variety of strategic interactions, including predation, self-defense, and collaboration. Finally, we provide empirical support for our model's predictions.

Keywords: Competition-Distress Feedback, Financial Contagion, Industrial Organization, Gross Profitability Premium, Financial Distress Premium

JEL Classification: G12, L13, O33, C73

Suggested Citation

Chen, Hui and Dou, Winston and Guo, Hongye and Ji, Yan, Predation or Self-Defense? Endogenous Competition and Financial Distress (January 3, 2020). Available at SSRN: https://ssrn.com/abstract=

Hui Chen

Massachusetts Institute of Technology ( email )

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

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Winston Dou (Contact Author)

The Wharton School, University of Pennsylvania ( email )

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

Hongye Guo

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

Yan Ji

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

Clearwater Bay
Kowloon, 999999
Hong Kong

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