Bankruptcy Risk, Product Market Competition and Horizontal Mergers

Posted by D. Daniel Sokol

Bernard Franck (Universite de Caen) and Nicolas Le Pape (Universite du Mans) discuss Bankruptcy Risk, Product Market Competition and Horizontal Mergers.

ABSTRACT: We consider an oligopolistic industry including leveraged …firms and unleveraged ones where …rms are engaged in a sequential decision-making process. At the fi…rst stage of the game, a …firm and her bank, considering the demand uncertainty and the distribution probability of the shock, evaluate a bankruptcy risk and, at the second stage, …firms are engaged in a Cournot competition. We characterize subgame perfect equilibria and we analyze the impact on these equilibria of the proportion of debt …nanced …firms in the industry. By introducing an additionnal upstream stage to the game, we then examine how debt …nancing impacts on incentives to merge with competitors. We demonstrate that a merger involving leveraged fi…rms increases the bankruptcy probability of the merging fi…rms while a similar merger concerning unleveraged …rms or between the two categories of …firms leads to a decrease in the bankruptcy probability of leveraged fi…rms. Moreover, the minimum number of …rms that must be engaged in the coalition in order to cause a pro…table merger, is lower in comparison with Salant, Switzer and Reynolds (1983). The welfare losses associated to anticompetitive e¤ects of mergers are lower when the coalition gathers unleveraged …rms rather than leveraged ones. Our model predicts that in evaluating proposed mergers Competition Authorities should take into account the …financial structure of both merging …firms and outsiders. Moreover the model justi…es the failing …rm argument when an unleveraged …firm takes over a leveraged one.