INVESTMENT DECISIONS AND FINANCIAL LEVERAGE UNDER A POTENTIAL ENTRY THREAT

This study examines investment and financing decisions of a pioneering firm and agency costs of debt in the presence of an entry threat by a potential competitor. It demonstrates that the over-investment problem demonstrated by Mauer and Sarkar (2005) remains in the presence of the potential entry threat. In addition, it demonstrates that when the pioneering firm increases leverage, a potential competitor expedites its market entry. Furthermore, high leverage creates the potential for inducing the competitor to enter the market in a downturn and exposing the pioneering firm to a risk of forced bankruptcy. Therefore, the potential entry threat hinders the pioneering firm from debt financing, and thus mitigates agency conflicts between shareholders and bondholders over investment decisions.