On financial frictions and firm market power

TitleOn financial frictions and firm market power
Publication TypeWorking Paper
Year of Publication2019
AuthorsCasares, M, Deidda, LG, Galdon-Sanchez, JE
ISBN Number978 88 68512 408
Keywordsbankurptcy, liquidation, Market power, moral hazard

We build a static general-equilibrium model with monopolistically competitive firms that borrow funds from competitive banks in an economy subject to financial frictions. These frictions are due to non verifiability of both ex post firm returns and managerial effort. Market power has opposing effects. On one side, firms’ pricing over marginal cost reduces output compared to perfect competition. On the other, by increasing firms’ profitability, market power reduces the impact of financial frictions. The resulting tradeoff is ambiguous. We show that, other things equal, there exists an optimal positive level of market power that maximizes welfare. Such optimal degree of market power increases with moral hazard and decreases with the efficiency of firm liquidation following bankruptcy.

Citation Key7230
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