Capital structure, product market dynamics, and the boundaries of the firm

Journal Article (Journal Article)

We model a new product market opportunity as an option and ask whether it is best exploited by a large incumbent firm (integration) or by a small separate firm (nonintegration). Starting from a standard framework, in which value-maximizing investment and financing decisions are jointly determined, we show that integration protects assets in place value, whereas nonintegration protects option value and maximizes financial flexibility. We show that increases in standard measures of cash flow risk predict exploitation of new opportunities by specialized firms, whereas increases in product market competition (e.g., the risk of competitive preemption) predict exploitation by incumbents. We also show that alliances organized as licensing agreements or revenue-sharing contracts sometimes better balance the sources of value and thus may dominate more traditional forms of organization. These organizational equilibria arise from the dynamic interaction of the new opportunity's option-like features with realistic competitive forces.

Full Text

Duke Authors

Cited Authors

  • Hackbarth, D; Mathews, R; Robinson, D

Published Date

  • December 1, 2014

Published In

Volume / Issue

  • 60 / 12

Start / End Page

  • 2971 - 2993

Electronic International Standard Serial Number (EISSN)

  • 1526-5501

International Standard Serial Number (ISSN)

  • 0025-1909

Digital Object Identifier (DOI)

  • 10.1287/mnsc.2014.2008

Citation Source

  • Scopus