Feedback and Contagion through Distressed Competition / Hui Chen, Winston Wei Dou, Hongye Guo, Yan Ji.

Format:

Book

Author/Creator:

Chen, Hui.

Contributor:

National Bureau of Economic Research.

Dou, Winston Wei.

Guo, Hongye.

Ji, Yan.

Series:

Working Paper Series (National Bureau of Economic Research) no. w30841.

NBER working paper series no. w30841

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2023.

Summary:

Firms tend to compete more aggressively in financial distress; this intensified competition, in turn, reduces profit margins, pushing themselves further into distress and adversely affecting their industry peers. To study such feedback and contagion effects, we incorporate strategic competition into a dynamic model with long-term defaultable debt, exploring various peer interactions like predation and price war. The feedback effect represents a novel source of financial distress costs associated with leverage, which helps explain the negative profitability-leverage relation across industries. Owing to the contagion effect, firms' optimal leverage is often excessively high from an industry perspective, undermining the industry's financial stability.

Notes:

Print version record

January 2023.