Competition and the Cost of Debt
Abstract
This paper empirically investigates how the intensity of product market competition affects the cost of debt. Using a large sample of loans to publicly traded US manufacturing
rms, I provide evidence that an intensi
cation of product market competition among fi
rms signi
cantly increases the cost of bank loans. The analysis reveals that the effect is strongest in industries with high illiquidity and speci
city of assets. This
finding indicates that the liquidation value of assets is an important channel through which competition affects the cost of debt. Moreover, I
find that loans to
firms that operate in more competitive industries contain more covenants restricting the
firms financing and dividend policies. Overall, the results suggest that banks explicitly take into account the risk arising from product market competition when pricing and designing debt contracts.