Jörg Oechssler and Frank Schumacher
"The limited liability effect in experimental duopoly markets"
JEL codes: L13, G33, D43
Keywords: oligopoly, bankruptcy, debt-equity ratio

Abstract: Brander and Lewis (AER, 1986) show that firms with limited liability can use debt to commit to aggressive behavior in Cournot markets. In our duopoly experiments, we find that subjects choose much less debt than predicted by theory. Although subjects try to exploit the strategic advantage of debt, they do not (want to) acknowledge possible strategic advantages of opponents' debt. Replacing quantity with price competition, our data support the theoretical prediction of Showalter (AER, 1995) that demand and cost uncertainty have opposing effects on the strategic choice of debt. However, observed behavior is more in line with collusion than with the subgame perfect equilibrium prediction.
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