Industry Equilibrium with Outside Financing and Moral Hazard: Effects of Market Integration

In this paper we study industry equilibrium and the effects of integration under the assumptions that 1) firms must use outside financing and 2) they face a moral hazard problem due to the possibility of taking excessive risks. These are typical features of banking and insurance, for instance. We examine an industry equilibrium where firms choose not to take excessive risks and compare this with the equilibrium in industries that do not have a moral hazard problem. We show that, as markets integrate, competition intensifies and prices fall in both types of industry. In markets with moral hazard there are relatively more exits, a smaller fall in prices and, contrary to the other case, the market value of the industry increases.industry equilibrium; outside financing; risk-taking behaviour; market integration