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Bankruptcy Cost, Financial Structure and Technological Flexibility Choices

We study the interactions between the capital structure and the technological flexibility choices of firms in a duopoly. When there are bankruptcy costs, a leveraged firm may modify its strategic choices in order to decrease its probability of bankruptcy. We show that, when the capacity level of the inflexible technology is small (large), debt may induce firms to choose less (more) flexible technologies. Debt may be used in a strategic way. We show that debt can be used as a partial collusion tool to increase the expected profits of both firms. We show also that a firm may use debt as a commitment device to increase its own expected profit to the detriment of its rival.
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