Capital Structure and Product Market Rivalry: How Do We Reconcile Theory and Evidence?

Abstract

This paper presents empirical evidence on the interaction of capital structure decisions and product market behavior. We examinine when firms recapitalize and increase the proportion of debt in their capital structure. The evidence in this paper shows that firms with low productivity plants in highly concentrated industries are more likely to recapitalize and increase debt financing. This finding suggests that debt plays a role in highly concentrated industries where agency costs are not significantly reduced by product market competition. Following the empirical evidence we introduce the "strategic investment" effect of debt and argue that this effect, in conjunction with agency costs, appears to fit the data.

JEL Classification: G32, L22