Running on Empty? Financial Leverage and Product Quality in the Supermarket Industry

Abstract

This paper examines whether debt financing can undermine a supermarket firm's incentive to provide product quality. In the supermarket industry, product availability is an important measure of a retailer's quality. Using U.S. consumer price index microdata to track inventory shortfalls, I find that taking on high financial leverage increases shortfalls. Highly leveraged firms appear to be degrading their products' quality in order to preserve current cash flow for debt service. Although reducing quality can erode both current sales and customer loyalty, firms appear to be willing to risk these outcomes in order to achieve benefits associated with debt finance.

Keywords: debt, financial constraint, inventory management, stockout, leveraged buyout

JEL Classification: D21, G31, G32, G34, L81, M31