Leverage and Value Creation in Holding-Subsidiary Structures
52 Pages Posted: 9 Dec 2009 Last revised: 18 Mar 2010
Date Written: December 8, 2009
This paper determines optimal capital structure and value of Holding-Subsidiary structures (HS), when there is a trade-off between bankruptcy costs and taxation. HS have higher firm value than their stand alone counterparts, as the holding provides a guarantee to its subsidiary’s lenders which lowers expected bankruptcy costs, at a given debt level. HS may also reach higher debt capacity, which further increases their value by reducing the tax burden below that of stand alone firms. Optimal debt in the holding and in the subsidiary are respectively lower and higher than in their stand-alone counterparts. Such debt diversity preserves the holding ability to rescue its subsidiary, hence value creation by HS, even with perfect cash flow correlation.
Keywords: holding, subsidiary, groups, guarantees, debt, taxes, bankruptcy costs, limited liability, capital structure
JEL Classification: G32, G34, L22
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