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A Theory of Predation Based on Agency Problem in Financial Contracting
Abstract
By committing to terminate funding if a firm's performance is poor, investors can mitigate managerial incentive problems. These optimal financial constraints, however, encourage rivals to ensure that a firm's performance is poor; this raises the chance that the financial constraints become binding and induce exit. The authors analyze the optimal financial contract in light of this predatory threat. The optimal contract balances the benefits of deterring predation by relaxing financial constraints against the cost of exacerbating incentive problems. Copyright 1990 by American Economic Association.
... Second, predatory threats from financially stronger rivals in competitive markets can directly undermine weaker firms' growth prospects. Bolton and Scharfstein (1990) explain that in highly competitive environments, stronger rivals may adopt aggressive pricing or production strategies to inflict losses on weaker firms, potentially driving them out of the market. Studies show that this competitive risk exacerbates idiosyncratic fluctuations (Gaspar & Massa, 2006;Irvine & Pontiff, 2009), raises financing costs (Valta, 2012), and discourages investment and productivity growth due to the uncertain returns on new investments (Aghion et al., 2005;Akdogu & MacKay, 2012). ...
... Conversely, the second perspective, which we label the "risk-increasing" argument, suggests that heightened competition increases the risk faced by firms. This perspective is rooted in predation theory, which suggests that financially stronger rivals may engage in aggressive pricing and production strategies to weaken their competitors, exacerbating the risk of failure for financially vulnerable firms (Bolton & Scharfstein, 1990). This particular situation amplifies default risk by eroding profit margins and increasing earnings volatility (Tirole, 2006), this leading to more conservative financial policies, such as avoiding debt altogether. ...
This paper investigates the impact of product market competition (PMC) on firms’ adoption of zero-leverage (ZL) strategies and examines whether this relationship is influenced by earnings volatility. Using data from 1989 to 2019, we analyze the PMC and ZL behavior of firms using logistic regression. Our results indicate that as PMC intensifies, firms are more likely to adopt ZL policies. This effect is stronger in firms with higher earnings volatility, suggesting a significant interaction between PMC and earnings volatility in shaping capital structure decisions. This study extends existing research by highlighting the role of earnings volatility in strengthening the relationship between PMC and ZL behavior, offering new insights into the dynamics between market competition, financial decisions, and firm risk.
... industries, where firms have more volatile cash flows, and gain from rivals' losses (Bolton & Scharfstein, 1990). Firms in more competitive industries may use their cash reserves to defeat rivals through aggressive pricing, or alternatively, to protect themselves from rivals' aggressive pricing (Bolton & Scharfstein, 1990). ...
... industries, where firms have more volatile cash flows, and gain from rivals' losses (Bolton & Scharfstein, 1990). Firms in more competitive industries may use their cash reserves to defeat rivals through aggressive pricing, or alternatively, to protect themselves from rivals' aggressive pricing (Bolton & Scharfstein, 1990). Additionally, firms in a competitive industry, where customer loyalty is low due to greater availability of suppliers (Matzler et al., 2015), have a higher demand for cash to build and maintain a competitive advantage through better marketing and store locations, more efficient logistic networks and the hiring of more skillful employees (Campello, 2006). ...
... In addition to these, key factors influencing the choice of cost leadership strategy include enterprise debt levels, market concentration, and market growth conditions. The limited liability theory suggests that high-debt enterprises tend to adopt cost leadership strategies to reduce risks (Brander and Lewis, 1986), while the deep pocket effect theory argues that low-debt enterprises can use low-price strategies to build market entry barriers (Bolton and Scharfstein, 1990). In low-concentration industries, cost leadership strategies are more popular, especially in continuously growing markets (Anwar and Li, 2021). ...
Purpose-This study investigates how corporations navigate the increasingly prominent field of environmental, social and governance (ESG) through the lens of resource dependence theory (RDT). It aims to elucidate the strategic responses of companies to media-driven public sentiment on ESG, examining the alignment of their operations and competitive strategies-specifically differentiation and cost leadership-to the external resource of media ESG sentiment.
Design/methodology/approach-Employing Python software, this research extracted over two million ESG-related news articles from Baidu News. Using machine learning and text analysis, the study assesses the media ESG sentiment and its correlation with the competitive strategies of China's A-share listed companies over a period from 2007 to 2022. The approach leverages RDT to understand how firms adjust their strategies in response to media-driven public sentiment on ESG.
Findings-The findings indicate that positive media ESG sentiment acts as a crucial external resource, significantly influencing firms' strategic alignment toward minimizing ESG public sentiment risks and enhancing competitive positioning, especially in the social (S) and governance (G) domains. This alignment is evident in firms' adoption of differentiation and cost leadership strategies, affirming the study's theoretical prediction within the RDT framework.
Originality/value-This paper provides a novel contribution by integrating RDT with the analysis of media-driven ESG sentiment to explore corporate strategic adjustments. It offers empirical evidence on the theory's applicability in contemporary strategic corporate management, particularly in the context of ESG challenges. The research deepens the understanding of the interplay between media ESG sentiment and corporate strategy, highlighting the strategic importance of positive media sentiment in the ESG landscape.
... I hypothesize that stronger NCA enforceability reduces firms' reliance on conservative financial policies and unused debt capacity, as the protection afforded by NCAs lowers the probability of trade secret misappropriation and predatory behavior by competitors. This hypothesis builds upon prior research highlighting the strategic role of financial flexibility in addressing competitive threats (e.g., Telser, 1966;Poitevin, 1989;Bolton and Scharfstein, 1990) and the importance of preserving unused debt capacity for mitigating unexpected financial needs (DeAngelo and DeAngelo, 2007;DeAngelo et al., 2011). ...
... Enhanced court credibility leads to a higher willingness to litigate [29]. Enterprises need to maintain financial flexibility to cope with increased legal disputes and litigation [30,31]. Moreover, litigation costs rise, compressing corporate profits, free cash flow, and financing capabilities [12]. ...
Judicial independence is an important means to strengthen the construction of the legal system, and its economic consequences have attracted much attention. Based on the quasi-natural experiment of judges' cross-regional exchanges in 2013 and using data from listed companies from 2009 to 2016, this paper explores the impact of judicial independence on corporate risk-taking. We find that there is a negative relationship between judicial independence and corporate risk-taking, and this conclusion remains valid after multiple robustness tests. Furthermore, the inhibitory effect of judicial independence on corporate risk-taking is more pronounced in companies with higher analyst pressure, higher retail investor pressure, or the presence of institutional selling. Mechanism analysis shows that judicial independence inhibits corporate risk-taking by increasing the amount of litigation and reducing net profit. These results are consistent with the logic that corporate managers reduce corporate risk-taking to alleviate performance pressure. This study provides a new perspective and strong evidence for the economic consequences of judicial independence.
... (Bolton and Scharfstein, 1990;Valta, 2012 (Karuna, 2007;Giroud and Mueller, 2011;Cheng et al., 2013;Dhaliwal et al, 2014;Ryu et al., 2014;Gu, 2016;Boubaker et al., 2018 (Lim and Kim, 2014;Jeon and Park, 2019;Park and Kim, 2019;Cha and Cho, 2023). 구체적인 측정방식은 다음과 같다. ...
In this study, we examined the relationship between market concentration using the Herfindahl-Hirschman index and firm values among listed companies in both the markets for the period 2011–2020. We found a negative association between market concentration and firm value. This relationship was mitigated by such factors as dividend payments, auditor size, and financial reporting opacity. This study contributes to the existing literature by corroborating the influences on firm value and addressing the prevailing research paradigm suggesting that market competition is a mechanism for overseeing managerial behavior (i.e., an external corporate governance structure).
... Our patent-level data, including the patent application date, grant date, patent technological class, patent value, number of citations, and firm identifier to which each patent belongs, are directly downloaded from Noah Stoffman's 15 As an example of the effect of competition on managerial career concern, Dasgupta et al. (2018) show the CEO turnover rate becomes higher when the product market is more competitive due to a reduction in import tariff cuts. 16 A firm becomes vulnerable to predation when its rivals strategically make use of the revealed information (Bolton & Scharfstein, 1990;Tirole, 1988), negative information in particular (Dai et al., 2020). To mitigate such predation risks, firms have the incentives of hiding the negative proprietary information, especially those that are extremely damaging (Bernard, 2016;Clinch & Verrecchia, 1997). ...
Motivated by the ethical dilemma in managerial financial reporting decisions, we explore and reveal an unintended “crash” consequence following accelerated patenting information dissemination. Employing the American Inventor’s Protection Act (AIPA) that accelerated the publication of patent applications, we find that accelerated dissemination of patenting information increases stock price crash risk. This effect is stronger when treated firms are technologically closer to their rival firms and more concerned about proprietary costs. Further analyses indicate that, the heightened crash risk following the AIPA is attributable to managers shifting towards less timely bad news disclosures. Overall, our study documents that accelerated dissemination of patenting information induces managers to strategically withhold negative information, which adds to the comprehension of what and how (un)ethical decisions are undertaken by managers.
... For example, reliance on debt finance exposes a firm with a high level of debt to the ruthless competitive policy of a low-debt rival that adopts a price reduction strategy. If the expected costs of the predatory behavior are significant, the high-debt firm would mimic the capital structure of the low-debt firm ( Bolton & Scharfstein, 1990). In this case, highly leveraged firms imitate the capital structure of their less leveraged peers in the same industry to reduce price competition from their more solvent rivals. ...
Rational imitation of financial policies, namely peer effects, was documented to prevail among firms within an industry in both developed and top emerging economies. Lacking evidence from medium-sized emerging Asian countries, this study examined intra-industry peer effects, i.e., imitation, on debt financing at Thai listed companies. The sample consisting of the firms listed on the Stock Exchange of Thailand (SET) during the years 2001–2018 was incorporated to discover those effects. Numerous databases associated with the SET (e.g., SETSMART) and the firms’ websites were used to collect financial numbers. With 6,058 firm-year observations, unbalanced panel data was then analyzed by using the random-effects and fixed-effects ordinary least squares models as well as the two-stage least squares regression. The main findings show that a focal firm imitates the long-term debt financing of its industry peers. Using the instrument approach to address endogeneity, the key results are confirmed. Peers’ equity shock as the instrumental variable decreases their financing with debt, subsequently lowering debt levels at a focal firm. This mimicking was operated through peer action, not peer character, i.e., performance. In additional tests, severe market competition was found to strengthen the uniformity of decision-making on debt finance among industry peers. Meanwhile, the high cost of information embedded in innovation-driven businesses has not been found to both promote and reduce peer effects on debt finance. Including the extra control variables at firm-specific levels, the key results remain robust. This study highlights a vein of social learning theory and competition-based theory in discussing herding behaviors toward all member firms in a certain industry. The conclusions enrich the literature on peer effects on debt finance policy.
... For example,Bolton and Scharfstein (1990) analyze the situation in which the disclosed information is not only used by investors to make investment decisions but also observed by competitors.Graham et al. (2005) notes that, while managers want to improve their reputation through transparent reporting, they are concerned that proprietary information, such as business investments representing a company's competitive advantage, may be used by competitors. ...
p class="MsoNormal" style="margin-top: 12pt; text-align: justify;"> This study considers the effects of disclosure conditions on firms' investment decisions when facing an identical competitor in multiple markets. Assuming that there are congestion costs between multiple investments to reduce marginal cost for each market, this study focuses on the cases where the disclosure conditions may differ by market. Like previous studies on single Cournot competition, these results show that firms invest more in the observable investment markets than in the unobservable markets under symmetric disclosure conditions. However, firms invest more in the unobservable market if there are asymmetric disclosure conditions. </p
... First, companies with higher real estate collateral value can improve their pricing power in the product market, allowing them to gain market share from competitors. Predation theory suggests that companies with ample financial resources can offer goods or services at lower prices, thereby reducing their competitors' profits and forcing financially weaker competitors to exit the market (Bolton & Scharfstein, 1990). ...
This paper introduces and investigates the hypothesis that the crowding-out effect surpasses the collateral effect, suggesting that an increase in the value of real estate holdings by companies hinders their competitiveness in the product market within emerging economies. Through our analysis, we elucidate the underlying mechanism, demonstrating that although Chinese listed companies benefit from their real estate holdings in terms of debt financing, these financial resources are predominantly reinvested in real estate projects rather than other productive endeavors. This effect is particularly pronounced when companies face significant financial constraints, operate in highly monopolistic industries, and are situated in regions where local governments heavily rely on land finance and face substantial pressure for GDP growth. By shedding light on the adverse implications of companies' real estate holdings and uncovering the factors contributing to the crowding-out effect, our research underscores the importance of enhanced regulations in the real estate markets of developing nations during the periods of irrational housing booms.
... In times of crisis, free financial resources enhance resilience by increasing the competitiveness of firms. Firms that have more reserve funds can pursue more aggressive strategies to displace competitors -e.g., through lower prices, more favorable credit terms, better service, etc. (Bolton, Scharfstein, 1990;Fresard, 2010). Moreover, cash holdings enable the acquisition of strategic assets at low prices, which brings significant competitive advantages in the long run (Chiu, Liaw, 2009). ...
The COVID-19 pandemic had significant global negative effects and posed significant challenges to corporate financial management. Firms that were more adaptable and robust achieved superior financial performance, underscoring the importance of resilience in corporate finance. Financial reserves, including cash holdings, played a substantial role in financial resilience serving as a buffer against negative external and internal shocks. Flexible investments and financing were another source of stability, enabling a quicker response to a rapidly changing environment. Furthermore, the accelerated pace of digitalization and the application of sustainable development principles also aided firms in navigating the crisis period more effectively. Overall, greater corporate financial resilience is essential for the successful long-term development of the company.
... The private equity placement is essentially a capital structure change event, which reduces the debt ratio of the firm by increasing equity. Meanwhile, it is the freeing up of space for future financing (Bolton and Scharfstein 1990;Maksimovic and Titman 1991). ...
This article conducts a review of the literature on private placement and analyzes the risks facing China’s real estate companies. It argues that, within the framework of China’s hybrid economic model, private placement can serve as a market-oriented financing mechanism and risk mitigation strategy beyond the traditional banking system. The article focuses on the characteristics of private placement, prevalent hypotheses, and influencing factors. It also traces the evolution of financialization in the global real estate industry, outlines the development model of China’s real estate sector, and discusses the challenges and risks it encounters. Private placement offers various advantages, including reducing corporate leverage, strengthening working capital, and addressing information asymmetry issues. However, existing research in this field is still insufficient. Therefore, future research can provide a more robust theoretical foundation and guidance for policymakers, investors, and businesses.
We examine the effect of product market competitors' listing delays on incumbent firms' defensive strategies, including efforts in customer retention and acquisition as well as merger and acquisition (M&A) activities. To establish causality, we use four regulation‐induced IPO suspensions in China that expose firms already approved for an IPO to indeterminate listing delays. Using a difference‐in‐differences design, we find that incumbent firms reduce efforts in customer retention and acquisition, as manifested in an increase in accounts receivable turnover and a decrease in selling expenses. Incumbent firms also reduce M&A activities, including high‐premium and horizontal ones. The effects are stronger for incumbent firms that are subject to more intensive competition from the suspended firm, face larger competitive pressure from existing public firms, and are more financially constrained. Additionally, incumbent firms' managers reduce competition‐related disclosures, and the firms' financial performance improves after competitors' listing delays. Consistent with the findings based on listing delays, we find that incumbent firms increase efforts in customer retention and acquisition and M&As surrounding competitors' IPO application and approval. Our paper sheds new light on the IPO peer effect, especially on how incumbent firms respond to the product market competitor's capital market entry.
This paper empirically investigates the relationship between product market competition and financial constraint of traditional US private colleges and universities. Using data for private, not‐for‐profit colleges and universities from 2006 to 2018, we create a synthetic credit rating using the Moody's Rating Methodology for Higher Education and generate market concentration measurements using enrollment data, geographic location, and incoming student SAT scores or acceptance rates. We find that higher market concentration is associated with greater financial constraint, schools with low‐scoring incoming students are more constrained when facing competition from peers with low‐scoring incoming students, and schools in markets with growing student populations have more financial constraint on average in less‐competitive markets and less financial constraint in more‐competitive markets.
To quote this resource: Dorian DUTOIT-PROUST, “Relevance and Effectiveness of sui generis instruments to tackle exclusionary practices in the Digital Economy”, Competition Forum – Resources, 2024, n° 0015, https://competition-forum.com
Competitive threats motivate firms to use convertible debt because the possibility of future conversion enhances financial flexibility. Consistent with this intuition, we find that the intensity of competitive threats is positively associated with convertible debt financing at both the extensive and intensive margins. By using large tariff reductions as exogenous shocks to competition we show that this relation is likely causal. Convertible debt usage in response to competitive threats strongly depends on a firm’s relative financial and competitive conditions. In addition, firms increase the probability of future conversion by tailoring convertible debt features. (JEL D34, G30, G32, G39)
Received: 11 September 2023; Editorial decision: 15 June 2024 Editor: Isil Erel
Corporate cash holdings decisions represent a key strategic decision for corporate managers, with consequences for the performance of both the corporate and economic growth of a nation. However, empirical studies have found evidence of persistently rising corporate cash holdings. Coincidentally, cash buildup in firms around the world has led to a reduction in dividend payouts over time. Modern-day corporations seem to have adopted a form of mercantilism by stockpiling cash that should otherwise be used for investment. Questions have been asked as to why corporate giants such as Apple have been sitting on large cash piles instead of spending them for growth, product development, and employment creation. The purpose of this chapter is to shed light on the drivers of corporate cash holdings and help readers acquire a better understanding of why firms hold so much cash. This chapter explains the motives behind corporate cash holdings, which include transaction, precautionary, agency, speculative, predation and tax motives. The theories that predict corporate cash holding decisions and how these decisions may be influenced by institutional and macroeconomic conditions are also discussed. The dominant theories of cash holdings are the trade-off, pecking order and agency theories. This chapter also discusses how the COVID-19 outbreak impacted the cash hoarding trend.
This study attempts to shed new light on how the state, as a minority shareholder, can affect the tax planning of non‐state‐owned enterprises (non‐SOEs). We examine publicly traded non‐SOEs in China and find that non‐SOEs engage in more tax avoidance when the government is a minority shareholder, indicating that minority state ownership has had a ‘shelter effect’ on tax avoidance of non‐SOEs. Further analysis shows that the sheltering effect of minority state ownership is more prominent for firms located in areas with heavier social burdens, worse tax enforcement and firms with stronger incentives to avoid taxes. Furthermore, non‐SOEs with minority state ownership increase excessive capital expenditures and employ redundant employees but still have higher firm value. Overall, our findings suggest the state, as a minority shareholder, shapes the tax‐planning activities of non‐SOEs in a ‘two‐way favour exchange’ manner and it is beneficial for non‐SOEs to maintain a close relationship with the government in China, where the government controls key resources.
We investigate a potential primary effect of leveraged buyouts (LBOs) by private equity (PE) on peers in the same industry using data on US public‐to‐private LBO transactions between 1985 and 2016. We use a network‐based instrumental variable approach to account for potential endogeneity concerns. Our findings indicate that the LBOs by PEs matter for peer firms' performance and corporate strategy relative to nonpeer firms. Our study supports a learning factor hypothesis, but we find no evidence to support the conjecture that peers lose due to the increased competitiveness of the LBO target.
The European Commission (EC) has recently announced its intention to issue Guidelines on exclusionary abuses. In this paper, we explain how economics can and should be used to inform a sound and effects-based approach in the enforcement of Article 102 TFEU. In particular, the EC should be guided only by a consumer welfare standard; exclusive dealing and exclusivity rebates should be subject to a (rebuttable) presumption of harm; price–cost tests are meaningful only for predation and other practices that do not reference rivals; essentiality of the input should not be a requirement for vertical foreclosure cases of any type, but such cases should be limited only to dominant firms that satisfy certain criteria.
We show that the supply of U.S. life annuities is constrained by interest rate risk. We identify this effect using annuity prices offered by life insurers from 1989 to 2019 and exogenous variations in contract-level regulatory capital requirements. The cost of interest rate risk management—conditional on the effect of adverse selection—accounts for about half of annuity markups, or 8 percentage points. The contribution of interest rate risk to annuity markups sharply increased after the Global Financial Crisis, suggesting new retirees’ opportunities to transfer their longevity risk are unlikely to improve in a persistently low interest rate environment.
I conjecture that a firm's sensitivity to industry shocks escalates its need to retain a cash buffer. Consistent with this conjecture, I find that a 1 SD increase in a firm's industry risk exposure increases cash holdings by 10%. In fact, industry risk has a greater effect on corporate cash holdings than does economywide and idiosyncratic risk in my sample. The effect of industry risk exposure on corporate cash holdings is greater for firms in highly competitive industries, as well as for firms with high leverage, a greater fraction of short‐term debt, and few tangible assets.
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Bengt Holmström ve Oliver Hart sözleşme teorisine ilişkin yaptıkları katkılarla 2016 yılında Sveriges Riksbank Ödülü ya da bilinen adıyla Alfred Nobel anısına verilen Nobel İktisat Ödülünü kazanmışlardır. Bu çalışmada her iki araştırmacının kısa hayat hikayeleri ve sonrasında sözleşme teorisine ilişkin öz bir bilgi verilmektedir. Ardından Holmström ve Hart tarafından bu alana yapılan katkılar sunulmaktadır. Hukuk ve iktisat ile hukukun iktisadi analizi çerçevesinde konular incelenerek sözleşme teorine ilişkin tespitler ortaya koyulmaktadır.
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