Market Competition and Shock Propagation: Implications for Margins and Distress

Joint with S. Johnson, Wei Wu

May 2025

Using local natural disasters as a quasi-experimental setting, we show that adverse shocks lead both directly affected firms and their unaffected competitors to reduce profit margins by approximately 0.8 percentage points. These reductions stem from intensified market competition, driven by mechanisms including predatory pricing, inventory liquidation, and weakened tacit collusion. As unaffected competitors cut margins nearly one-for-one in response, their financial distress rises significantly, though not directly shocked. Spillover effects are concentrated in tradable industries and those with high entry barriers, large inventories, greater price flexibility, or tight financial constraints, revealing a novel channel for shock propagation across the economy.