Exit and contraction decisions are an important part of a firm’s strategic planning as much as investment and expansion policies. A number of factors related to the states of the economy and the industry as well as to the firm characteristics can contribute to a firm’s exit decision from its product market. For instance, firms may be operating in mature industries in which demand may be shrinking, rendering firms unable to cover their costs. Likewise, a recessionary period may lead a firm to experience difficulties it has not encountered in a boom period with high asset values. Industry concentration and firm characteristics can be another crucial factor in the exit decision. In an oligopolistic market, for example, a firm may engage in predatory pricing, in expectation of inducing higher exit probability of a weaker competitor (see Chevalier and Scharfstein (1996) and Klemperer (1995)). In sum, exit decisions can be attributed to a complex interplay of several factors ranging from the aggregate to the individual firm level.

Firm characteristics can be perceived as a channel through which macroeconomic conditions and industry factors determine the exit decision. The same economic factors will affect firms differently as they exhibit cross sectional asymmetries. One important firm characteristic is the financial structure. Over the past two decades, there has been a surge in interest in the relationship between product market competition, on the one hand, and capital structure on the other hand. Some theoretical models such as those of Brander and Lewis (1986) and Maksimovic (1988) predict a more aggressive competitive behavior as a result of higher leverage while others show that leverage makes product market competition softer. The relationship has also come under scrutiny in the empirical literature that focuses on pricing and exit decisions. Chevalier (1995), for example, explores the effect of leveraged buyouts (LBOs) on the pricing in the supermarket industry. She finds that in markets in which rival firms are also highly leveraged, prices rise following the LBO. She also finds evidence of predatory pricing in markets in which the LBO firm faces less leveraged rivals. Similarly, Phillips (1995) and Phillips and Kovenock (1997) investigate the effect of large recapitalizations on the subsequent product market performance and survival of firms. They find that firms that have undergone a large recapitalization are less likely to invest and more likely to shut down plants.