Essays in Finance and Product Market

Abstract

This dissertation consists of three essays which explorer the interaction between finance and product market choices. In the first essay, “A Corporate Finance Model with Customer Dynamics: The Leverage-Profitability Puzzle,” I develop a dynamic trade-off model with quantity and pricing decisions where firms take into account their short term impact on profitability and long term impact on customer base. The model provides a novel mechanism that explains the leverage-profitability puzzle and makes new predictions about the leverage-profitability relation that are supported in the data. In the second essay, “Quality versus Quantity Strategies in Product Markets,” we study the strategies that monopolistic competitive firms follow as they respond to traditional shocks to technology and to quality-improving shocks. Our main modeling assumption is that demand is more sensitive to quality than it is to market share. This assumption is responsible for having quality shocks be the main driving force for most of what corporations do as opposed to traditional technology shocks. It also helps explain why firms with higher quality products have higher debt and lower credit spreads. In the third essay, “Is Mismeasurement of Real Consumption Due to Product Turnover Relevant for Asset Prices?” I examine the long-standing equity premium puzzle, and test whether mismeasurement in real consumption due to ignoring quality changes embedded in product turnover has an effect. I find that the change in real consumption volatility is not sizable to account for the puzzle.