Financial Structure and Market Equilibrium in a Vertically Differentiated Industry

Jean Lefoll () and Stylianos Perrakis ()
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Jean Lefoll: HEC-University of Geneva and FAME

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

Abstract: This paper examines the effects of uncertainty and the choice of financial structure in a vertically differentiated duopoly. In the market model consumers are located along a continuum of taste parameters and prefer unanimously higher to lower qualities when quality prices are set at average variable cost. In such a model only two firms can survive with a positive market share. We introduce uncertainty in demand by varying the range of the consumer taste parameter and consider a simultaneous game of sequential choices of quality, financial structure and product price, with varying order of decision-making and revelation of information. We consider both restricted and free entry. It is shown that financial structure affects market equilibrium, which is also heavily dependent on the order of choice of structure and quality, as well as on whether uncertainty exists in the lower or the upper limit of the taste parameter. In all cases leverage increases the lower quality and in most cases it also increases the lower quality price. There are also welfare implications, with the use of leverage when it is optimal improving both total and consumer surplus.

Keywords: Vertical differentiation; uncertainty; financial structure; leverage; quality; sequential choice (search for similar items in EconPapers)
JEL-codes: C70 G32 L11 L13 L15 (search for similar items in EconPapers)
Date: 2002-12
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