|
Over the past few decades, research in finance has found that under the assumption of asymmetric information in the financial markets, managers of publicly held corporations may use financial policy decisions to send signals to market participants of their firm's true value. Methods to convey this information are techniques such as capital structure changes, dividend policy, and repurchases, to name a few. Ross (1977) suggests that increases in leverage may be used by the managements to signal a bright future, while Masulis (1980) finds that stock prices are positively related to leverage changes. Asquith and Mullins (1983) and Denis et al. (1994) find that dividend initiations and changes in dividends have information content as well, while Dann (1981) finds that repurchase announcements have significant announcement effects. Studies continue to examine the reasons and methods which managers use to convey information to investors. Most of the previous studies implicitly assume firms are in perfect competition and the influence that one firm's action can exert on another is negligible. Yet, in industries where competitor's actions could significantly affect other firms, because they are a few in numbers or they have similar substitutable product lines, there may exist strategic advantage to harm, sabotage, or support major actions planned by competitors. Thus, models which have solely focused on manager's consideration of investor's perception of their firm's market values as a reason for signaling have omitted the important strategic interaction which takes place among firms in industries with a few major competitors.
A few years ago, Carnival Corporation, in an effort to prevent P&O Princess PLC from merging with Royal Caribbean Cruises Ltd., came up with its fourth hostile offer for P&O. A Royal Caribbean-P&O merger would put together the industry's number two and number three cruise lines and displace Carnival as the industry leader. Richard Fain, Royal Caribbean's chairman, claims this offer is no more real than the previous ones. The $5.4 bn short-term offer would have reverted to a rejected $5.1 bn offer if 15% of P&O's shareholders did not pledge to vote for an indefinite delay of the merger. In fact, Fain said in a statement, "Carnival's goal is to scuttle our meeting, secure in the knowledge that any price offered will never need to be paid." In an industry such as cruise lines in which there is competition among the few, known as an oligopoly, firms may engage in strategic behavior in order to ensure their survival. Typically, the focus on this behavior has been on predatory pricing.
Over the past two decades, there have been numerous studies on predatory pricing in the field of economics and whether firms can choose to cut prices to lower their rival's profits and induce them to leave the market. Some economists have claimed that predation has occurred, while others have argued that this technique would not be rational (McGee, 1958). In fact, in the late 1970s, most believed that predatory price cutting would rarely, if ever, be profitable. Soon after, many game theoretic papers concluded that with the existence of asymmetric information, an established firm can benefit from manipulating potential entrants' beliefs about the returns to entering an industry (Kreps and Wilson, 1982). In a similar vein, this study considers the manipulation of both competitors' and outside investors' belief. Studies made earlier relied on reputation effects in which the predator preys to signal information about himself; however, later studies, including Fudenberg and Tirole (1986), examine a `signal-jamming' theory of predation in which the predator preys to jam or interfere with the potential entrants inference about their own profitability. Thus, the predator's characteristics are common knowledge and he preys not to signal information about himself but rather to `jam' or interfere with the inference problem faced by the entrant. This study is unique in the sense that it examines the competition among firms in the case of predatory pricing, and analyzes the factors that prevent the new entrants into the market. Other studies which have examined the entry of competitors include Verrecchia (1990) and Wagenhofer (1990). These authors find that the disclosure of bad news deters the entry of competitors.
In corporate finance, mergers and acquisitions (M&A) have been a common phenomenon in order to take advantage of synergies such as economies of scale and scope, technology sharing, and managerial expertise. A merger or acquisition is one way to gain instant access to markets as well as a method to become the top dog in an industry. Carnival cruise lines' fear of losing its number one place in the industry drove it to take defensive actions in order to prevent such a merger. Although Fain claimed that Carnival's offer was not real, getting involved in a bidding war for a potential target may not necessarily be the best defensive measure to undertake. This could become very costly. Hence, it would be important to find out if there are cheaper means to acquire the same result, which is the failure of a competitor's intended action. If Carnival's offer truly is not real, but only to `scuttle' the merger meeting as Fain claims, then Carnival is attempting to `jam' or interfere with Royal's shareholder's decision-making process. Thus, they are attempting to signal jam. |
