Product market competition and financial default: evidence from Italian private firms

Abstract

This study investigates the relationship between product market competition and financial default in private firms and the moderating role of group affiliation in this relationship. The empirical research uses a sample of Italian firms and a multivariate regression approach. It augments Altman’s default prediction model with three measures of competition: product market fluidity, HHI, and Li’s (2010) measures of competition. It analyzes the in-sample and out-of-sample prediction abilities of models augmented by competition. The findings show that competition has a significant positive association with default, suggesting that the risk-increasing effect of competition prevails over the disciplinary effect. Interaction analysis provides evidence that group affiliation moderates the effect of competition on default. Group-affiliated private firms are less likely to default than non-group-affiliated firms at similar levels of competition, signaling a disciplinary effect channeled by group affiliation. Furthermore, we find that adding product market fluidity to Altman’s model significantly increases its predictive ability. This study contributes to the literature on the financial outcomes of competition with evidence of private firms. This shows that group affiliation moderates the relationship between competition and defaults. This study also contributes to financial default studies with evidence that competition enhances default predictions. This study suggests that competition indicators might be used in financial distress early warning systems for private firms the European Union is recently promoting.