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In other situations, leverage makes firms less aggressive competitors. This leads to lower output and higher prices
A firm with financial slack will often prey on a highly levered firm: it will take actions to steal its market share 17 Empirical Evidence The empirical evidence supports the idea that high leverage weakens a firm’s competitive position and leads to loses in market share. Highly leveraged firms lose market share during industry downturns, when high debt leads to financial distress:
– Underinvestment problems reduce investment: they cut back on investment and sell off assets
– Difficulty to keep or attract customers: firms producing specialized products lose more market share
– Rivals steal its customers: a firm with a large market shares attracts predators in concentrated industries 18 Empirical Evidence Industry studies of cases with large changes in leverage: Industries where one or more of the largest firms substantially increased their leverage experienced lower output and higher prices (Phillips & Chevalier). The industry competition becomes less aggressive.
Firms are sometimes more likely to enter and expand in markets where large incumbents are highly leveraged (Chevalier’s supermarket study). Consistent with predation.
19 The Massey-Ferguson Case
Objectives: Explore the concept of optimal debt ratio based upon basic business risk and competitive risk
Show the implications of an aggressive debt ratio policy that is inconsistent with an aggressive corporate strategy
Assess the cost of too much debt as the loss of competitive position resulting from financial distress
Study the interaction between competitive strategy and financial policy and the use of finance as a weapon
Gain insight into financial distress and the available remedies, including restructuring operations and financial claims, and the role of interested parties (e.g., governments) in providing funding and guarantees. 20 The Massey-Ferguson Case
Case Outline Massey’s corporate & financial strategy in successful years of 19711976 What went wrong after 1976? Massey’s response Competitor’s response Massey’s options to solve its financial problems How the refinancing worked in practice Deere’s strategy starting in 1981 Connection to tradeoff theory of capital structure
21 The Situation in 1980 (exhibits 1-4) MF is a multinational producer of farm machinery, industrial machinery, and diesel engines Unprecedented loss of USD 262.2 million in 1978 New president tries...
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