Excess Liquidity against Predation

Dai Zusai

No 25, TUPD Discussion Papers from Graduate School of Economics and Management, Tohoku University

Abstract: To investigate why a firm may hold excess liquidity, we examine a duopoly competition in which a shallow-pocket entrant needs the financial support of an outside investor to pay for input costs and launch a business. We allow the investor to terminate the entry if they find the incumbent react too aggressively to the entry plan. However, such an exit option creates a threat of predation by a deep-pocket competitor. To avoid predation, the entrant must raise precautionary liquidity by taking out a loan both larger and further in advance than is actually needed. An entrant with little start-up capital will be less aggressive if the incumbent's capacity size is unverifiable, because the need to raise precautionary liquidity restricts the entrant's feasible capacity size.

Pages: 42 pages
Date: 2022-08
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Persistent link: https://EconPapers.repec.org/RePEc:toh:tupdaa:25

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