Capital Structure And Pricing Strategy In Duopoly

The interaction between financing decisions and product market competition has been the recent focus of financial economists and industrial economists. Empirical evidence indicate that capital structure changes affect firm and it's rivals' investment, pricing strategy and performance.This paper examines the relationship between financial decisions and pricing strategy in oligopoly. Assuming a duopoly market structure, when firms raise prices they initially realize higher profits, but lower market shares, which in turn implies lower profits in the future. We analyze how financial distress costs that are induced when the firm is unable to meet the first period debt obligations affect the firm's behavior in output markets. Assuming financial distress causes the distressed firm's market share lower; while the rival firm get the external benefits of bankruptcy, and gain market shareUnder Nash price competition, whether or not firms choose to use strategic debt depends on the type of uncertainty that exist in the output market. When costs are uncertain, firms will not use debt because it does not hold a strategic advantage. When demand is uncertain, the firms will not use debt or use positive strategic debt, depending on the value of parameters.However, if the firm is a Stackelberg follower, a Stackelberg leader may see a rival's commitment to a less aggressive pricing strategy, arising from its leverage increase, as offering it an opportunity to steal market share at a reduced cost. This tendency to steal market share will be higher for the less leveraged leader, which places a higher value on the long-term benefits of the increased market share.