Preemption, leverage, and financing constraints

This paper investigates the interactions between preemptive competition and leverage. We find that the second mover always leaves the duopoly market before the first mover, although the leader may exit before the follower’s entry. We also see the leverage effects of debt financing increasing firm values and accelerating investment, even in the presence of preemptive competition. In addition to the case with optimal capital structure, we analyze a case with financing constraints that require firms to finance investment costs by debt. Notably, financing constraints can delay preemptive investment and improve firm values in preemptive equilibrium. Indeed, the leader’s high leverage due to the financing constraints can lower the first-mover advantage and weaken preemptive competition. Especially with strong first-mover advantage, the financing constraint effects can dominate the leverage effects. These findings are almost consistent with empirical evidence that high leverage leads to competitive disadvantage and mitigates product market competition. JEL Classifications Code: C73; G31; G33.