This volume examines the interaction of capital structure and product market competition. The first chapter investigates how upstream firms use trade credit to affect downstream firms behavior in imperfect competition. The second chapter explores the impact of price matching on firms' advertising investments in a price duopoly game and the last chapter focuses on how an incumbent firm adopting a price matching strategy changes its investments to accommodate a new entrant.
Chapter 1 explains trade credit financing as a strategic tool for a supplier to influence her retailer behavior in a product market, provides a new rationale for the existence as well as the contract structure of trade credit financing, and shows why financially unconstrained firms occasionally finance their inventory with expensive trade credit. In our model competing supply chains deliver a homogeneous good to a market with imperfect competition where retailers have to make inventory decisions before demand is realized. When demand is weak trade credit financing makes the retailer more aggressive as he avoids having to finance unsold inventory at the high trade credit interest rate. The ex-ante expected cost of having to finance excess inventory at the high trade credit rate when demand is weak reduces retailers' optimal ex-ante inventory levels. When demand is high sales are constrained by inventory and competition is less intense. The modified product market behavior induced by trade credit financing increases the producer surplus at the expense of consumer surplus in oligopoly markets, while we find no benefit for producers in either monopoly or perfect competition.
Chapter 2 examines how a price matching strategy affects a firm's advertising decision under price duopoly competition. Price matching serves as a double-edged sword for firms' investments in advertising, profits and social welfare. Specifically, if a firm's advertising benefits to both firms, a price matching strategy increases advertising investments, profits, and consumer surplus relative to the Bertrand equilibrium. This arises as price matching effectively reduces market competition and mitigates the free-riding problem of advertising, giving both firms strong incentives to invest. Conversely, if advertising is predatory, price matching harms both firms and consumers due to over-investment. Price matching moves competition between firms solely into the realm of advertising, thereby exacerbating the externality effects.
Chapter 3 studies how price matching affects an incumbent firm's investment to accommodate a new entrant prior to competition. A simple theoretical model is developed to investigate the interaction among price matching, the incumbent firm's investments (R&D and advertising) as well as product market competition. The price matching policy has a significant effect on such investments but the impact works totally oppositely on investments for demand enhancement and cost reduction. Compared to Bertrand competition, price matching facilitates advertising investment but impedes R&D investment.