On the Impact of Financial Structure on Product Selection

Christos Constantatos and Stylianos Perrakis ()

Discussion Paper Series from Department of Economics, University of Macedonia

Abstract: We examine the interaction between financial and microeconomic decisions in a differentiated duopoly under uncertainty as to consumer taste for quality. Financing is by equity and debt and product specification is endogenous. We consider two three-stage games, according to the order of moves: qualities-financial structure-prices and financial structure-qualities-prices. Once debt is contracted, the manager maximizes equity instead of total value. We find that in both games debt a) increases both prices and qualities but most likely reduces product differentiation due to rival quality response; b) reduces the value of the levered high quality firm because it increases the low quality. Moreover, c) the cost of debt is higher for the second game, implying that it is higher for projects using debt to finance a product’s development-cum-commercialization compared to those financing only the commercialization stage. The results turn out to be robust to alternative specifications of quality and market size uncertainty.

Keywords: Vertical differentiation; uncertainty; financial structure; leverage; sequential quality choice. (search for similar items in EconPapers)
JEL-codes: G32 L00 (search for similar items in EconPapers)
Date: 2010-11, Revised 2010-11
New Economics Papers: this item is included in nep-bec, nep-com and nep-mic
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