Leaders vs. followers

: investigating the impact of falling interest rates on firm borrowing and investment responses

Abstract

This thesis analyzes the strategic effect established by Liu et al. (2022), which describes the asymmetric investment responses of industry leaders and followers during periods of falling interest rates. When interest rates fall, the present value of being a persistent market leader increases. Assuming that firms can become permanent leaders through investments, the incentive to invest increases causing intense competition if leaders compete head-to-head. The expectation of fierce and costly competition disincentivizes followers to invest, causing an asymmetric investment response. This strategic effect increases if the interest rate approaches zero and reverses if it increases. Using the methods of Kroen et al. (2022), the borrowing and investment behaviors of firms in response to negative interest rate shocks in eleven Eurozone countries from 1999 to 2021 are analyzed. Leaders are defined as the top 5% of firms based on annual revenues within their 2-digit NACE industry. The results show that falling interest rates close to the zero lower bound causes increased leverage, borrowing, and investments of leaders relative to followers, justifying the strategic effect. Contrary to the proposed financial advantage followers enjoy lower borrowing costs than leaders. Both effects diminish in higher interest rate environments. A competition-neutral ESTER rate of 3,47%, at which rate shifts influence industry leaders and followers equally, is computed. The results confirm a pronounced strategic effect in more competitive industries with lower Herfindahl-Hirschman Index, consistent with the proposal by Liu et al. (2022) that leaders competing head-to-head investment more aggressively, while followers are disincentivized to invest.

Date of Award	17 Oct 2023
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Joana Silva (Supervisor)