High Discounts and High Competition

Winston Wei Dou, Finance, The Wharton School; Yan Ji, Hong Kong University of Science and Technology; and Wei Wu, Mays Business School

Abstract: We build an industry equilibrium model with dynamic strategic competition to jointly explain the fluctuations in competition intensity, profitability, and asset prices. Product market competition endogenously intensifies as discount rates rise, because firms compete more aggressively for current cash flows by undercutting each other as the present value of future cooperation decreases. Competition intensity responds differently to aggregate discount-rate shocks across industries. In industries with a lower turnover rate of market leaders, firms’ profit margins tend to be higher yet more exposed to discount-rate fluctuations, thereby generating the gross profitability premium. We exploit exogenous variations in market structure — large tariff cuts — to test the model directly. Empirical evidence based on textual analysis also supports model implications.

Read the full working paper here (PDF).

Michelle Eckert is Marketing and Communications Coordinator for the Mack Institute, where she works to engage students, researchers, and corporate partners in opportunities for collaboration. Michelle received her B.A. in Art from Valparaiso University in 2007. Her background includes two AmeriCorps terms of service working to teach mathematics, computer literacy, and job readiness skills to out-of-school youth in Philadelphia, focusing particularly on promoting access to post-secondary education.