Winston Dou

Competition Network: Distress Spillovers and Predictable Industry Returns

We build a competition network of industries — two industries are connected if they share at least one multi-industry firm that competes as a major player in both, referred to as a “common market leader” of these two industries. Exploiting quasiexperiments induced by the local-natural-disaster occurrences, Lehman failure, and American-Jobs-Creation-Act passage, we find that firms hit by adverse distress shocks cut their profit margins, and in response, their “untreated” industry peers, driven by intensified competition pressure, also cut profit margins and become more likely to violate covenants or default. Further, distress shocks and the resulting changes in competition intensity can propagate to other industries through financially-consolidated common market leaders, especially when they are already financially constrained. Such cross-industry spillovers, with investors’ learning frictions, rationalize industry return predictability through the competition-network links.