Competition and the Cost of Debt

http://www.fma.org/Hamburg/Papers/competition_debt_v3.pdfWorking Paper, Swiss Finance Institute and Ecole Polytechnique Fédérale de Lausanne, Extranef 24This paper empirically investigates how the intensity of product market competition affects the cost of debt. Using a large sample of loans to publicly traded US manufacturing rms, I provide evidence that an intensication of product market competition among firms signicantly increases the cost of bank loans. The analysis reveals that the effect is strongest in industries with high illiquidity and specicity of assets. This finding indicates that the liquidation value of assets is an important channel through which competition affects the cost of debt. Moreover, I find that loans to firms that operate in more competitive industries contain more covenants restricting the firms financing and dividend policies. Overall, the results suggest that banks explicitly take into account the risk arising from product market competition when pricing and designing debt contracts