Financial Signalling and the "Deep-Pocket" Argument
Volume: Volume 20, No. 1
Issue: Spring 1989
Pages: pp. 26-40
Authors: Michel Poitevin
Title: Financial Signalling and the "Deep-Pocket" Argument
Abstract: This article provides a formal representation of Telser's (1966) "deep-pocket" argument by considering a model in which the entrant's and the incumbent's financial structures are endogenous. The entrant's financial vulnerability may be explained by informational asymmetries in financial markets. Financiers are uncertain of the entrant's true value, but they know the incumbent's true worth. Both firms have to finance a fixed expenditure before starting production. In equilibrium the incumbent finances with equity, while the high-value entrant comes into the market heavily leveraged compared with the incumbent. This provides an incentive for the incumbent to engage in predatory practices such as a price war to exhaust the entrant financially and cause his bankruptcy.
JEL Classification
Microeconomics Theory of Firm and Industry under Imperfectly Competitive Market Structures (0226)
Market Structure: Industrial Organization and Corporate Strategy (6110)
Theory of Uncertainty and Information (0261)
Business Finance (5210)