Finance and Competition

Abstract

Financial constraints are commonly thought as representing a barrier to entry and expansion for new and small firms, thus potentially limiting competition in product markets. We investigate the role of financial constraints for product markets in the context of a general equilibrium, two-sector model, where firms differ in terms of both efficiency and financial constraints. The amelioration of financial constraints can lead to firm entry, smaller average firm size, lower concentration and more competition (lower markups) in financially dependent sectors - the patterns observed in the data - if such constraints afflict disproportionately the smaller firms. This requires a positive correlation between ability and capital ownership. In all other cases, the amelioration of constraints leads to greater concentration and less competition. In the former case incumbents will oppose while in the latter case they will favor financial liberalization.

Keywords: financial development, liberalization, market structure, product market competition

JEL Classification: L1, E2