Financial structure and firm operating policy

This dissertation studies the way in which capital structure influences a firm's operating decisions and product market behavior. In the first chapter, we analyze how share price pressure can lead to managerial myopia as managers face incentives to make short-run decisions as modeled in Stein (1989). We show how long-run debt can negate myopic behavior by serving as an incentive to have high future earnings in order to avoid the risk of costly bankruptcy. The model shows how increases in leverage were a signal in response to growing share price pressure in the 1980's. It yields a theory of capital structure whose predictions are in line with recent empirically observed patterns, unlike the previous signaling models such as those of Myers and Ross. The model also predicts the recent series of corporate bankruptcies, and it demonstrates the benefits of high bankruptcy penalties in inducing efficient decision making. It then shows how debt may, ex post, lead to inefficient decisions being taken in an effort to pay it off. This ex post consequence of debt can potentially undermine its ex ante incentive benefits. In the second chapter we study the nature of predatory behavior in an oligopolistic framework. We use the long-purse story to demonstrate that predatory behavior is less likely to occur in an oligopoly than in a monopoly. We show the nature of the free-rider problem involved, and illustrate the range of multiple equilibria that may exist in this situation. In the third chapter we take the oligopoly model of Brander and Lewis and extend it in order to examine the consequences of bankruptcy for product market competition. We find that firms are less aggressive than Brander and Lewis predict. Firms with intangible assets will have higher outputs than firms with tangible assets. This effect strengthens as debt levels rise, and we show that firms with intangible assets will wish to adopt higher debt levels than their competitors.