Review of Industrial Organization 20: 267–282, 2002.
© 2002 Kluwer Academic Publishers. Printed in the Netherlands.
Debt and Firms’ Relationships: The Italian
CLAUDIO A. G. PIGA
University of Nottingham Business School, Wollaton Road, Nottingham NG8 1BB, U.K.
Abstract. Theories that predict the strategic use of debt by players engaged in a vertical relationship
are tested using an empirical model of debt usage. It is found that ﬁrms selling mainly to other
ﬁrms are characterised on average by a higher level of debt. No evidence supports the notion that
buyers increase their leverage to commit themselves not to behave opportunistically towards their
suppliers. The results in the paper also suggest that group organisation limits the incentive to use
debt strategically within the holding-subsidiaries relationship.
Keywords: Capital structure, contract theory.
JEL Classiﬁcations: G32, L14.
A relatively new and important strand of literature has highlighted that strategy fol-
lows capital structure. Brander and Lewis (1986) were the ﬁrst to demonstrate that
under demand and/or cost uncertainty, Cournot ﬁrms can use short term debt to en-
hance their position in the product market. Glazer (1994) extends their analysis by
considering the effect of long term debt on market competition. Showalter (1995)
modiﬁes the Brander and Lewis model to show that under price competition, the
use of strategic debt is advantageous only in the presence of demand uncertainty,
but it is disadvantageous when costs are uncertain.
The hypothesis of a connection between a ﬁrm’s ﬁnancial structure and its
behaviour in the product market has also received careful consideration in the
empirical literature. Chevalier (1995) ﬁnds that the announcement of a leveraged
buy-out in the U.S. supermarket industry increases the market value of the rival
ﬁrms, and that entry is more likely to occur in those local markets where a large
share of incumbents undertook a LBO. Both results suggest that debt “softens”
product market competition, which is in stark contrast with the prediction of the
I would like to thank Giovanni Scanagatta and Antonio Riti from Mediocredito Centrale for
kindly providing the data used in the study. I am indebted to Don Siegel for his insightful comments.
Any remaining errors are my sole responsibility.