Naveen Khanna

Investment timing decisions under threat of potential competition: Why firm size matters1

Abstract We study the value of the option to wait when other firms are looking at similar opportunities and may enter while one firm is waiting for uncertainty resolution. There are two important results. First the value of an investment project is affected by a firm’s assets-in-place, giving some firms a comparative advantage in competitive situations. Second, when two firms with different sized assets-in-place are looking at similar investment decisions, in the unique sub-game perfect equilibrium, the smaller firm invests earlier and also exits before a competing firm with larger assets-in-place. This makes an otherwise identical investment more valuable for the smaller firm. The larger firm optimally foregoes first-mover advantage because of higher expected exit costs.

Optimal debt contracts and product market competition with exit and entry

We show how competition in oligopolies, with the possibility of failure and exit of a levered incumbent, affects the ex-ante design of optimal debt contracts. When a levered firms profits are unobservable, a debt contract imposes the threat of nonrenewal to induce truthful revelation. Because nonrenewal impacts the future profitability of the surviving competitor, the contract influences the competitors pricing strategy and the equilibrium profits of both firms. The optimal contract is quite different from a standard debt contract, and induces the competitor to be less aggressive, resulting in higher equilibrium prices and profits, and higher returns for investors.