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



is funded, it then enjoys a monopoly position; otherwise, the two firms com-
pete in the product market, which makes expected industry-wide profits lower.
Defining V
M and ViC as monopoly profit and duopoly profits net of agency
costs,
10 the interesting case clearly arises when:

VM >V1C +V2C

that is, when the investor (who captures the surplus from lending) should
optimally let just one firm enter the industry and deny funding to other firms.
From the point of view of the investor, this is clearly a matter of financial entry
deterrence: if he does not offer funding to the second firm, the latter cannot
enter. But in fact, matters are not so simple. Readers familiar with the
foreclosure literature will guess that the investor faces a commitment problem
in not funding Firm 2. After having funded Firm 1, the investor may have an
incentive to behave opportunistically and also let Firm 2 enter the industry.
To be more specific, assume Firm 1 is naive and signs the financial contract
expecting to enjoy a monopoly position; it may then be ex-post optimal for
the investor to expropriate firm 1 by funding Firm 2 as well. In equilibrium
Firm 1 will anticipate this opportunistic behavior, so the investor would like
to commit not to fund firm 2. This commitment problem is what - by analogy
to the new foreclosure doctrine - we call the investor’s Coase problem.
11 Thus
in what follows we will refer to successful financial entry deterrence as having
solved the investor’s Coase problem.
12

Two features of our model are crucial for the Coase problem to arise: first,
when Firm 1 signs the financial contract with the investor, it does not observe
whether Firm 2 is being funded or not (note that contracting need not be
sequential; the Coase problem would also arise with simultaneous and secret
contracts). Second, the contract with Firm 1 cannot be made contingent on
whether Firm 2 is funded.

1 0 A formal definition for VM and ViC will be given later.

11The Coase problem is so-named because of the further analogy with Ronald Coase’s
(1972) discussion of the commitment problem faced by a durable good monopolist.

12 Notice that although economists are accustomed to thinking in terms of credit-rationing,
from the industry point of view what the investor faces here is a problem of over-funding.
As in the foreclosure literature, the investor always has incentives to supply more than the
ex-ante optimal amount of credit to the downstream firms.



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