Product market competition, debt rollover risk and financial default risk: evidence from Indian corporates

Abstract

Purpose

The study investigates the impact of the interaction effect of product market competition and rollover risk on the default risk of the firms.

Design/methodology/approach

The study used the sample of unbalanced panel data from Indian corporates without any survivability bias over the period from 2009 to 2020 consisting of 30,396 firm-year observations of 6,718 firms spread across 143 industry groups. The panel data regression tests the interaction effect in the context of the asset substitution problem, predation threat theory, competitive shock, and competitive risk.

Findings

The empirical results highlighted the dominance of the predatory effect of competition over the disciplinary advantage of short-term debts. The competitive shock to the industry results in a higher credit spread for refinancing short-term debt and significantly increases rollover risk for firms. Smaller firms have higher default risk from rollover losses than larger firms in the face of competition due to asset-substitution problems and strong rivalry. For firms with weaker fundamentals, the interaction effect of rollover risk and competition exacerbates the flight-to-quality problem, resulting in a systemic event.

Practical implications

The investors can benefit by factoring ex-ante the interdependence of competition, debt market illiquidity, and default premia while calculating the credit risk. The shareholders of competitive firms can reduce the moral hazard of refinancing the rollover losses and defaulting at a higher fundamental default threshold, by reducing sub-optimal utilization of funds by managers and agency costs.

Originality/value

As per the best of author knowledge, the present study is the first to study the moderating effect of product market competition in exacerbating default risk through the rollover channel.

Citation

Chaturvedi, A. and Singh, A. (2024), "Product market competition, debt rollover risk and financial default risk: evidence from Indian corporates", Managerial Finance, Vol. 50 No. 10, pp. 1837-1856. https://doi.org/10.1108/MF-11-2023-0726