Product Market Performance, Switching Costs, and Liquidation Values: The Real Effects of Financial Leverage

43 Pages Posted: 19 Mar 2005

See all articles by Murillo Campello

Murillo Campello

Cornell University - Samuel Curtis Johnson Graduate School of Management; National Bureau of Economic Research (NBER)

Zsuzsanna Fluck

Michigan State University - Department of Finance

Date Written: March 2006

Abstract

We model the interaction of product market competition and firms' financing decision when firms face capital market imperfections and consumers face switching costs. In our model, consumers anticipate that capital market frictions may drive their supplier out of business and account for welfare losses that firm bankruptcy imposes upon them. Likewise, managers, when investing in long-term market share building, take into account the possibility of business failure and the residual value they may capture from the firm's liquidation process. Our theory yields four central implications. In response to a negative shock to demand: (1) more leveraged firms will experience significant market share losses; (2) the market share losses of more leveraged firms will be more pronounced in industries where low debt usage is the norm; (3) the market share losses of more leveraged firms will be more pronounced in industries where consumers face higher switching costs; and (4) the market share losses of more leveraged firms will be magnified in industries where asset liquidation is less efficient. Using detailed firm- and industry-level data from U.S. manufacturers over the 1990-91 recession, we present empirical evidence supporting our model's predictions. We later expand our empirical analysis, studying a large panel of firms over the various phases of the full business cycles contained in the 1976-96 period. Results from these broader tests provide additional evidence in support of our theory.

Keywords: Leverage, product market competition, switching costs, asset liquidation, endogeneity, business cycles

JEL Classification: G32, D43, E32

Suggested Citation

Campello, Murillo and Fluck, Zsuzsanna, Product Market Performance, Switching Costs, and Liquidation Values: The Real Effects of Financial Leverage (March 2006). AFA 2007 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=686435 or http://dx.doi.org/10.2139/ssrn.686435

Murillo Campello (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

114 East Avenue
369 Sage Hall
Ithaca, NY 14853
United States

HOME PAGE: http://www.johnson.cornell.edu/Faculty-And-Research/Profile.aspx?id=mnc35

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138

Zsuzsanna Fluck

Michigan State University - Department of Finance ( email )

Eli Broad Graduate School of Management
315 Eppley Center
East Lansing, MI 48824-1122
United States
517-353-3019 (Phone)
517-432-1080 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
826
rank
27,773
Abstract Views
3,910
PlumX Metrics