Legal-System Arbitrage and Parent-Subsidiary Capital Structures

Forthcoming, Management Science

33 Pages Posted: 17 Mar 2012 Last revised: 8 Jan 2018

See all articles by Suman Banerjee

Suman Banerjee

Stevens Institute of Technology; Stevens Institute of Technology

Thomas H. Noe

University of Oxford - Said Business School; University of Oxford - Balliol College; Bank of Finland; European Corporate Governance Institute

Date Written: March 12, 2016

Abstract

This paper develops a new theory of the capital structure of parent--subsidiary organizations based on legal-system arbitrage: The capital structure of parent--subsidiary organizations is chosen to minimize the agency costs generated by selective renegotiation of claims written on the component legal entities. We show that optimal mixes of parent--subsidiary level financing minimize the default premia associated with the organization's overall financing package by equating the marginal enforceability of debt contracts written at the parent and subsidiary level. The enforceability of creditor claims depends not only on the legal regime but also on the size of the debt claims and the liquidation value of the firm's assets. Small claims written under a weak creditor rights regime may be more enforceable than large claims written under a regime with strong creditor protection. Thus, all optimal mixes involve some borrowing at the subsidiary level even if the subsidiary legal regime features weaker creditor protection than the parent regime. However, the mix between parent and subsidiary financing tilts toward the regime that features stronger creditor protection.

Keywords: Conglomerate, Capital structure, Debt renegotiation, Multinational corporation, Parent-Subsidiary Organizations

JEL Classification: G15, G32, G33, G38, K4

Suggested Citation

Banerjee, Suman and Noe, Thomas H., Legal-System Arbitrage and Parent-Subsidiary Capital Structures (March 12, 2016). Forthcoming, Management Science . Available at SSRN: https://ssrn.com/abstract=2022875 or http://dx.doi.org/10.2139/ssrn.2022875

Suman Banerjee

Stevens Institute of Technology ( email )

525 River Street
Hoboken, NJ 07030
United States
2012613689 (Phone)

Stevens Institute of Technology ( email )

Hoboken, NJ 07030
United States

Thomas H. Noe (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 3BJ
United Kingdom

University of Oxford - Balliol College ( email )

Broad St
Oxford, OX1 3BJ
United Kingdom

Bank of Finland ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

European Corporate Governance Institute ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Register to save articles to
your library

Register

Paper statistics

Downloads
119
Abstract Views
1,055
rank
234,473
PlumX Metrics