Product Market Predatory Threats and the Use of Performance-sensitive Debt

We use a variant of the Hotelling (1929) model to illustrate that, when a firm faces hard payment constraint(s), financially strong rivals may adopt predatory strategies to drive the firm out of the product market and hence to obtain extra profit from enhanced market power later on. Predation is more likely to occur if the payment constraint is contingent on the firm’s performance. The model predicts that higher predatory threats in the product market reduce firm’s use of performance-sensitive debt and this effect should be more pronounced for small firms with large growth opportunities. Through a sample of over 16,000 bank loans to U.S. borrowers in 1997-2008, we find empirical evidence to support these model predictions.