Bankruptcy cost and the theory of oligopoly.

This paper examines the relationship between financial decisions and output decisions in oligopolistic markets. Assuming a duopoly market structure in which financial decisions and output decisions follow in sequence, we analyse how bankruptcy costs that are incurred when the firm is unable to meet current debt obligations affect the firm's behaviour in output markets. With fixed bankruptcy costs, firms have an incentive to increase output levels if they take on more debt. Proportional bankruptcy costs lead to a u-shaped relationship between output and debt. Foresighted owners of firms are led to take into account the strategic output effects of financial structure when considering an optimal financial structure for the firm. [ABSTRACT FROM AUTHOR]