The Impact of Debt Financing on Entry and Exit in a Duopoly

Abstract

This article investigates the interaction between market entry, company foreclosure, and capital structure in a duopoly. We find that the order in which firms foreclose is determined not only by differences in firm-specific factors, but also by common economic factors, such as the interest rate and the market profit volatility. We extend the exit model by allowing financially distressed firms to renegotiate their debt contracts through a one-off debt exchange offer. We find that firms with high bankruptcy costs or with prospects of profit improvement can get bigger reductions on their debt repayments. Investigating market entry, we find that financial vulnerability of the incumbent induces earlier entry.