ANTI-COMPETITIVE FINANCIAL CONTRACTING: THE DESIGN OF FINANCIAL CLAIMS.

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Contracts:

Financial contracts simply state a rule for s_nplitting t_ohe cash-flow. More
precisely, a contract is a pair of real numbers R_b^L ,R_b^H specifying the en-
trepreneur’s payoff in case of failure and success. Any borrower is protected
by limited liability; therefore R_b^L ≥ 0 and R_b^H ≥ 0. We assume that it is impos-
sible to write an exclusive dealing contract, imposing some form of punishment
for the investor contingent on whether he funds the new entrant Firm 2. Very
likely, such a contract would be illegal and thus not enforceable.⁹ Moreover,
since Firm 1’s success or failure are both consistent with either competition or
monopoly, the parties cannot circumvent this legal constraint by contracting
on revenues.

2.2 Entry Deterrence and the Coase problem

The industry has the same structure as in the foreclosure literature. The
investor plays the role of an upstream monopolist, providing downstream firms
with an essential input to the production process (money); there is potential
competition in the downstream industry, but it can develop only if both firms
have access to funding.

The investor can offer a contract to one or both firms. If only one firm

⁹An alternative reason why a contract which is directly contingent on firm 2’s existence
is not used lies in the difficulty of verifying whether firm 2 is indeed competing with firm 1.
An exclusive dealing clause would then be inefficient in that it might discourage funding of
valuable, non-competing firms. More generally, we believe that because the legal process is
time-consuming and costly, parties may prefer to use financial rather than legal incentives
to prevent competition emerging.

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