Effects Of Capital Structure On Product Market Competition

In the past years, the relation between capital structure and competition among firms in product market relates to two different science fields, this is of Corporate Finance and Industrial Organization. The fact that the firm's capital structure decision and the management strategy in product market have long been studied in two isolated fields makes the failure of the two researches consider the interactions between the capital structure and the strategy of the firm in product market, resulting in the difficulty of reasonably explaining the actual corporate behavior and even opposite conclusions, due to the restraint of presuppositions. Until 1980's, this separation in research has caused wide attention of many economists and they explored the interaction between these two decisions from various viewpoints. They find that Capital structure decision and product market decision are the two most important decisions in firms' developing process and these two decisions have close interactions.A detailed literature review suggests that until now no consensus has been reached on the relationship between firm's capital structure and product market competition, and no standard theoretical framework is being used in related studies as well. Starting from different presuppositions, previous research drew two contradictory conclusions, one being that capital structure accelerates market competition while the other viewing totally the opposite. Ultimate research findings seem to be conditional upon factors such as the varieties of product market competition and various aspects of firm's product market. Existing empirical studies have attempted to testify the two viewpoints respectively. But so far domestic research has failed to analyze the variety of industries, mostly taking listed firms in the manufacturing industry as examples. The industrial nature is one of the key factors influencing capital structure. Because factors such as competition status, product cycle and control of ownership differ in different industries, the relationship between capital structure and product market competition must inevitably vary. Consequently, the findings of empirical research on firms of different industries can not fully depict the role that the industry plays. On the basis of an empirical study into a variety of listed companies in China, the present study aims at discovering two points: firstly, to what extent capital structure in various industries influence product market competition under the circumstances of different competitive environments; secondly, what are the potential causations of such influences.The paper starts with a theoretical analysis of the influences that capital structure has on product market competition. It is observed that firms choose gearing mainly because of uncertainties resulting from demand or cost. When there is a high level of debt, firms have more incentives to choose quantity strategy. Accordingly, they gain more profits with the increase of sales when everything runs well. Shareholders generally ignore the decrease of profits in the case of bankruptcy as creditors are the ones to claim the remaining possessions. For shareholders, with the change of debt, the distribution of profit varies. Capital structure seems to be a sign of the market, transmitting via limited liability of debt and impacting on firms and competitive environment among firms in the industry. The theoretical framework used by the researcher is the model of Gabrielle Wanzenried (2003) which suggests a two-stage differentiated goods duopoly model with demand uncertainty linking firms' capital structure choices with their output market decisions, proving that the debt issue induces firms to increase their output when firms' industrial circumstance is uncertain under an exogenous specific shock.Based on the literature review, drawing upon data collected from numerous listed companies in several industries in China, the researcher conducted an empirical study, aiming at testifying conclusions of Gabrielle Wanzenried (2003). The factors taken into consideration when choosing industries are production intensiveness, industrial chain and the degree of state control on them. Five industries such as pharmaceutical industry, food and beverage industry, metallurgy industry, transportation equipment industry as well as wholesale and retail trade are selected. Analyses of capital structure and features of market competition in the five industries reveal that the debt level is generally lower than the average nationwide. Obviously, listed companies prefer not to take high risks of too high gearing ratio. Meanwhile, there is vast difference in capital structure among industries. Findings of the study indicate that the influence of capital structure on product market competition differs in various industries. For example, in the technology-intensive industry such as pharmaceutical industry and the capital-intensive industry such as metallurgy industry and transportation equipment industry, which institutional barriers is high, capital structure has a positive impact on product market competition; while in the labor-intensive industry such as food and beverage industry, wholesale and retail trade, the two are negatively related.The innovativeness of the present research is threefold. Firstly, it is the first empirical test of Gabrielle Wanzenried's (2003) theoretic model on listed companies in China. Secondly, it is a study on firms of different industries. There exists significant distinction in the field of product market competition among firms of different industries. As the nature of the industry is one of the key factors influencing the choice of capital structure, it is of more practical significance and achieves better objectivity to apply the test to many a different industries. Thirdly, the tentative exploration into the causations of capital structure's effect on product market competition is of value to some extent. It is believed that firms' limited liability of debt serves as a commitment to the market, signaling to other firms in the industry that its competitiveness would be tougher or milder.