Money as a weapon: Financing a winner-take-all competition

Banerji, Sanjay; Fang, Dawei

Abstract

We study capital structure of pioneering startup firms who are often credited with opening of new markets and niches in the digital era and often face the threat of potential entry of successful, cash-rich firms from adjacent markets. Our analysis is made in the context of a winner-take-all competition in the form of an all-pay auction for the monopolistic position in a new market. We show that in such scenarios, a pioneer's optimal capital structure exhibits widespread diversity and is determined by a tradeoff between entry deterrence and post-entry competition intensification. In particular, our results show that a pure-equity (a mixture of equity and risky debt) structure is optimal when (1) barriers to entry are small (large), (2) the future prospect of the new market is fairly certain and/or (3) the externality of winning/losing the new market on the potential entrant's existing business is large (small). The post-entry competition is likely to engender large losses on both the winner and the loser. Keywords: all-pay auctions, capital structure, financial constraints * We thank participants at IFABS Chile conference 2018 and the joint finance workshop between Gothenburg and Lund 2019 for helpful comments and suggestions. We thank the editor, Douglas Cumming, and two anonymous referees for detailed and insightful comments that improved the article in many ways. Dawei Fang gratefully acknowledges financial support from Browaldh Stiftelsen and VINNOVA (grant 2010-02449).

Citation

Banerji, S., & Fang, D. (2021). Money as a weapon: Financing a winner-take-all competition. Journal of Corporate Finance, 66, Article 101783. https://doi.org/10.1016/j.jcorpfin.2020.101783

• Journal Article Type: Article
• Acceptance Date: Nov 2, 2020
• Online Publication Date: Nov 20, 2020
• Publication Date: 2021-02
• Deposit Date: Feb 23, 2021
• Publicly Available Date: May 21, 2022
• Journal: Journal of Corporate Finance
• Print ISSN: 0929-1199
• Electronic ISSN: 0929-1199
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 66
• Article Number: 101783
• DOI: https://doi.org/10.1016/j.jcorpfin.2020.101783
• Keywords: All-pay auction, Capital structure, Financial constraint, Winner-take-all market
• Public URL: https://nottingham-repository.worktribe.com/output/5345907
• Publisher URL: https://www.sciencedirect.com/science/article/abs/pii/S0929119920302273
• Additional Information: This article is maintained by: Elsevier; Article Title: Money as a weapon: Financing a winner-take-all competition; Journal Title: Journal of Corporate Finance; CrossRef DOI link to publisher maintained version: https://doi.org/10.1016/j.jcorpfin.2020.101783; Content Type: article; Copyright: © 2020 Elsevier B.V. All rights reserved.