Capacity Liquidation, Financial Contracts, and Conglomerate Mergers
Date Issued
2015
Date
2015
Author(s)
Chen, Chih-Hao
Abstract
This thesis studies the interaction between the external financing and the product market competition of an incumbent firm through the capacity liquidation. The liquidation of the production capacity diminishes not only the firm’s maximum production level, but also the capacity price. Both effects encourage the rivals to behave more aggressively and promote entry. Therefore, capacity liquidation increases the short term liquidation income but declines the long term profits from the product market competition. Moreover, the capacity liquidation may intensify the agency problems in financial contracts because the profits become more volatile after new entry occurs. When the states of profits are unverifiable in financial contracts, the uncertain future income may make the investors unable to breakeven. To make the contract feasible, the firm should increase the pledgeable income by changing the liquidation level. I show that both over liquidation and under liquidation may increase the total pledgeable income. The liquidation level in the optimal contract depends on market environments. After the firm designs the contract, the contract conversely affects the market competition through the capacity decision. Finally, I consider the conglomerate merger with efficient internal capital markets, which mitigates firms’ financial constraints and hence improves the efficiency of the liquidation decision. This theory provides an explanation for the US merger wave in 1980s.
Subjects
Capacity
Asset Liquidation
Financial Contracts
Agency Problems
Limited Pledgeability
Conglomerate Mergers
Type
thesis
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