Entry, exit and mergers: a competitive equilibrium model with financial frictions

Abstract

This paper examines a dynamic stochastic model of a competitive industry with heterogeneous firms that allows for entry, exit and mergers of firms in equilibrium. The model we build is an extension of a modified version of Jovanovic and Rousseau's (2002) model that introduces financial frictions, describes the market for corporate control and endogenizes its equilibrium price, and develops a stationary equilibrium à la Hopenhayn (1992). It provides a theoretical framework within which to study factors affecting variables such as entry, exit and investment through direct unbundled capital good purchase and mergers. This work contributes to the literature by suggesting another explanation to many empirical regularities and describing one more mechanism through which aggregate liquidity shocks may affect merger activity. The results suggest that due to asymmetric information about entrepreneur's survival probabilities aggregate liquidity shocks may contribute to codetermine the turnover rate of firms and investment levels through mergers.