Agency Costs of Debt in Conglomerate Firms
72 Pages Posted: 4 Oct 2017 Last revised: 16 May 2022
Date Written: October 22, 2020
Abstract
I use an accounting reform to assess the agency cost of debt in diversified firms. Those firms that switch from single to multiple segments following the reform suffer a 12% increase in their bond spread when compared to their stand-alone peers. Consistent with lenders anticipating under-investment and asset substitution incentives, diversified firms with high cash-flow volatility across divisions suffer the highest increase in borrowing costs. I employ a novel approach that allows abstracting from unobservable characteristics that would otherwise influence the pricing of diversified firms' debt.
Keywords: Diversified Firms, Cost of Debt, Free Cash Flow, Subsidiary Debt, Internal Capital Markets, Bonds
JEL Classification: G12, G15, G30, L22
Suggested Citation: Suggested Citation