Capital Structure and Product Market Competition: Evidence from the EU Life Insurance Industry

It is a conventional wisdom that solvency regulation decreases product market competition. The thesis argues that this view could be erroneous. The existing literature overlooks a fundamental risk-incentive mechanism associated with imperfect product markets. This thesis develops a theory that embeds the product market frictions' mechanism and the traditional costs of equity financing mechanism to explain product market decisions. The theory predicts that insurance premium is a "U" shaped function of the solvency ratio. The study of the natural experiment in the United Kingdom (UK) life insurance industry in 2005 supports the theory.