Product Market Competition, Cash Shortage and Financing Choices

In response to intensified product market competition identified by the exogenous industrial deregulations and significant import tariff cuts, this paper finds that firms with different initial cash conditions react differently in choosing their financing methods, resulting from the interplay of different incentives. In anticipation of more competition from potential rivals, firms maintain their financial flexibility either by building up cash reserves if they are in short of cash, or by reducing debt issuance if they have plenty of cash. Moreover, firms with cash shortage aim at avoiding the higher financial risk in a competitive market: they rely more on unsecured debt with less loss in liquidation value, long-term debt with lower rollover risk, and private debt with less information leakage. In comparison, firms without cash shortage rely internal funds as their primary funding resources, and they deviate from those external funds with higher monitoring incentives, such as secured, longterm, and private debt, suggesting their incentive to substitute external monitoring with the competitive market discipline.