We investigate how competitive behavior affects the capital structure of a firm. Theory
predicts that the impact of different types of output market uncertainty (in particular,
unanticipated shocks in demand and costs) on a firm’s leverage depends on the type of
competition in an industry. We test these predictions in a sample of U.S. manufacturing
firms by classifying firms into Cournot competition (strategic substitutes), and Bertrand
competition (strategic complements). We show that demand uncertainty is positively
related to leverage for firms in both the Cournot and the Bertrand sample. Cost uncertainty
has a significantly positive impact on the leverage of Cournot firms, but plays a negligible
role for Bertrand firms. Our results support the strategic use of debt and highlight the role
of firms’ competitive behavior in the product market in their capital structure decisions.