We show how product market competition affects capital structure using a tractable market equilibrium model with heterogeneous, imperfectly competitive firms. The model embeds the trade off between bankruptcy costs and the benefits of debt in limiting private benefit extraction by managers. Different determinants of competition|fixed production costs and product substitutability|have contrasting implications for the effects of competition on firm leverage. Firms in more competitive industries with greater product substitutability are more leveraged, whereas firms in more competitive industries with lower fixed production costs have lower leverage. We show robust support for these predictions in our empirical analysis of U.S. non financial firms.​

JEL codes: G30, G32

Keywords: imperfect competition, leverage, industry equilibrium.​