Predators or Defenders? Endogenous Competition and Financial Distress

Topic:

 Predators or Defenders? Endogenous Competition and Financial Distress

Time&Date: 

 16:00-17:15 pm, 2019/8/27 (Tuesday)

Venue:

  Room 619, Teaching A

Speaker:

 Prof. Hui Chen (Massachusetts Institute of Technology)

Firms tend to compete on prices more when they are in financial distress, while more intense competition can reduce firms' profit margins and push weaker firms further into distress. To study the quantitative effects of the feedback loop between industry competition and financial distress, we incorporate dynamic games of price competition into a general equilibrium framework, where changes in macroeconomic conditions further enriches the interactions between price competition and firms' credit risks. We show that this feedback mechanism amplifies the risks of financial distress and endogenously generates jump risk in cash flows. The magnitude of these effects depends on the heterogeneity in customer base and financial conditions across firms within an industry. Interestingly, even under implicit collusion, financially strong firms would appear to implement a ''predatory'' pricing strategy, which increases the risks of default for financially weak firms. Finally, we provide empirical support for our model's main predictions.