Competition Increases X–efficiency: A Limited Liability Mechanism

The main result of this study is that a financial constraint may serve as a disciplining device on the internal efficiency of a firm, and the tougher the product market competition, the higher the disciplining power. This limited liability mechanism may, in part, account for the alleged disciplining power of product market competition on firm efficiency. However, even if policies that promote competition enhance x-efficiency, the gain may be outweighed by a less efficient allocation of risk. Moreover, this adverse risk-effect has repercussions, implying that the effect of reduced entry barriers on competition and consumer's welfare is small.