Do firms respond to competition in corporate finance decisions? Evidence from India’s Competition Act

Abstract We select a sample of non-financial listed Indian firms to analyse the effect of competition on innovation and on firms’ corporate finance decisions. Using firm-level data for 3,716 companies from 1998 to 2006 sourced from the CMIE Prowess database, we exploit the Competition Act (2002) in India as an exogenous policy shock and apply a difference-in-differences ( DiD ) framework to estimate its causal effects. The findings show that treated firms innovated between 0.19% and 2.51% more than control firms after the enactment of the Competition Act (2002). However, these firms did not exhibit higher capital expenditure or external financing; instead, they reduced leverage—particularly secured debt—and exhibited more cautious risk-taking, while dividend payouts remained broadly unchanged. Overall, the 2002 reform enhanced innovation while inducing financial conservatism. This pattern aligns with Arrow’s (1962) competition–innovation mechanism and the financial-flexibility view that, in emerging markets, stronger competition pushes firms to become more efficient and innovative while encouraging prudent financial behaviour. This study offers the first clear evidence from an emerging economy showing that competition policy reform can both encourage innovation and promote careful financial behaviour. It adds to the ongoing debate about whether competition drives firms to take more risks or makes them act more conservatively in their financial decisions.