Strategic Liability in the Corporate Group

66 Pages Posted: 17 Jan 2011 Last revised: 8 Sep 2011

See all articles by Richard Squire

Richard Squire

Fordham University School of Law; European Corporate Governance Institute (ECGI)

Date Written: January 23, 2011


The typical large corporation divides itself into numerous subsidiaries but then overrides the liability barriers between them by having the subsidiaries and the parent company cross-guarantee each other’s major debts. Previous scholarly theories of the corporate group cannot explain why. The leading theory posits that the subsidiaries make it easier for creditors to evaluate risk because they enable each creditor to lend against a discrete asset pool within the broader enterprise. But any such efficiency would be undercut by the guarantees, which transmit credit risk across subsidiary boundaries. This Article argues that the combination of subsidiaries and intragroup guarantees reflects a type of shareholder opportunism termed correlation-seeking. Because the insolvency risks of the entities in the typical corporate group are highly correlated, the intragroup guarantees provide the group’s shareholders with a one-way bet. The guarantees lower the interest rates on the guaranteed debts, thus enriching the shareholders as long as the group stays solvent. And if the group falls insolvent, the triggering of liability on the guarantees makes no difference to the shareholders, whose equity stakes are wiped out anyway. The guarantees instead dilute the recoveries of the group’s nonguaranteed creditors. This separation of burden and benefit induces firms to form too many subsidiaries and to overuse guarantees, thereby undermining transparency, complicating bankruptcy proceedings, and introducing other distortions. Current fraudulent transfer doctrine perversely upholds those guarantees that are most likely to be overused. Doctrinal reform based on risk correlations would deter guarantee overuse and would reduce bankruptcy courts’ dependence on the controversial remedy of substantive consolidation.

Keywords: Bankruptcy, correlation-seeking, guarantee, corporate group, fraudulent transfer

JEL Classification: G33, G32, K22

Suggested Citation

Squire, Richard C., Strategic Liability in the Corporate Group (January 23, 2011). University of Chicago Law Review, Vol. 78, 2011, Fordham Law Legal Studies Research Paper No. 1742096, Available at SSRN:

Richard C. Squire (Contact Author)

Fordham University School of Law ( email )

150 West 62nd Street
New York, NY 10023
United States
212-964-1584 (Phone)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

Do you have negative results from your research you’d like to share?

Paper statistics

Abstract Views
PlumX Metrics