Product market competition and optimal debt contracts: The limited liability effect revisited

This paper shows that asymmetric information between lenders and borrowers plays a crucial role in the existence of interactions between financial dec isions and output market strategies. Lenders offer an optimal, renegotiatio n-proof financial contract which resembles a standard debt contract. Comput ing Cournot equilibria, debt causes firms to compete less aggressively: the usual(positive) limited liability effect on quantities is offset by a nega tive one due to (endogenous) financial costs. (C) 2000 Elsevier Science B.V . All rights reserved. JEL classification: L13; L14; G30.