Predation due to adverse selection in financial markets

An entrant can alleviate adverse selection problems in financial contracting by conditioning its own survival on future assessments made by financial markets. However, an incumbent may then engage in predatory behavior to try to adversely affect these markets' assessments and make exit more likely. We examine optimal financial contracting in the presence of this predatory threat, both when renegotiation is feasible, and when it is not. In contrast to previous literature, a contract that would be suboptimal in the absence of a predatory threat may optimally deter predation, even under competitive capital-markets and renegotiation. (C) 2004 Published by Elsevier B.V.