Essays on investments and financing decisions in complementary networks systems

This dissertation studies investments and financing decisions in the presence of complementarities and network effects.; Chapter 1 describes some brief case studies of Mergers and Acquisitions and partnerships in the software industry as a means of illustrating how firms can exploit complementarities to obtain competitive advantages and create value.; The second chapter of the dissertation is an empirical study that: (1) tests the hypothesis that there is value in equity participation between companies that produce different components of a complementary network; and (2) empirically validates the software "stack". The "stack" is a structure in which the complementarity between products is highest when the two products are on adjacent layers. In a sample of Mergers and Acquisitions, in which either the acquirer or the target is a software firm, I find an inverse curvilinear relationship between abnormal returns and the distance between acquirers and targets in various layers of the stack. Abnormal returns are higher when both sides in the acquisition are classified in adjacent layers of the stack and smaller when acquirer and target are further apart on the stack or are on the same layer. I interpret this as evidence that complementarity increases the value of the investment. In a comparable sample of alliances, I find that abnormal returns around the announcement date are higher if both sides produce in the same layer of the stack. These results seem to suggest that complementary network effects are a source of value creation in Mergers and Acquisitions and that there is value in equity participation between complementary components of networks that goes beyond the value of strategic contracts.; Chapter 3 introduces a theoretical model that explores how financial contracts between firms producing complementary products can increase value by creating additional incentives to each party. It shows that when one firm's funding is constrained, it is optimal to obtain financing from a producer of complementary products rather than from an independent investor. Even if there are no funding constraints some amount of external financing from complementary entrepreneurs may increase the value of an investment. The model explains how incentives to exert effort increase with uncertainty and how investors who participate in higher risk complementary ventures have more incentives to exert effort in their own ventures. The model also explains why subsidizing a venture in a complementary business may increase the value of a project, by increasing incentives in the complementary venture.