More Pronounced Pecking Order in Face of Intensified Product Market Competition

This paper examines how U.S. public firms’ financing decisions react differently to intensified product competition given their different cash shortage levels. We find that the pecking order in capital structure becomes more pronounced in a more competitive market, identified by exogenous industrial deregulation and significant import tariff cut. It is the firms with cash shortage that increase their reliance on external debt and equity financing. They build up cash reserves to maintain financial flexibility, as a substitute for reducing debt issuance. Their debt composition change implies the incentive to avoid financial risk: they rely more on unsecured debt to avoid liquidation value loss of potential collaterals, long-term debt to avoid rollover risk, and private debt to avoid information leakage and maintain renegotiation flexibility. In contrast, firms without cash shortage deviate from those external funds with higher monitoring incentives, such as secured, long-term, and private debt, suggesting that they substitute external monitoring with the market discipline. Moreover, changes in debt composition are mainly driven by the recapitalization purpose, but the change in equity issuance is more consistent with changes in investment activities.