THE STRATEGIC EFFECTS OF LONG-TERM DEBT IN IMPERFECT COMPETITION

When rival firms issue long-term debt, their product market behavior i s driven by strategic considerations that would not be present if the firms had no debt or if their debt was short term. It is shown that wi th limited liability, a firm's behavior in product market competition can be strongly affected by its accumulated profits. In markets where firms choose output in every period, the higher is the firm's profit i n a given period, the less aggressive it will be in the subsequent per iods. Thus, by issuing long-term debt rival firms may induce collusive behavior over some length of time. Furthermore, the path of equilibri um prices and the degree of price fluctuations may be entirely differe nt depending on the structure of the firms' debt.