Separate or Joint Financing? Coinsurance, Risk Contamination, and Optimal Conglomeration with Bankruptcy Costs
70 Pages Posted: 17 Mar 2012
Date Written: January 31, 2012
This paper analyzes the determinants of the optimal scope of incorporation in the presence of bankruptcy costs. Bankruptcy costs alone generate a non-trivial trade-off between the bene fit of coinsurance and the cost of risk contamination associated with financing projects jointly through debt. This tradeo-off is characterized for projects with binary returns, depending on the distributional characteristics of returns (mean, variability, skewness, heterogeneity, correlation, and number of projects), the structure of the bankruptcy cost, and the tax advantage of debt relative to equity. Our predictions are broadly consistent with existing empirical evidence on conglomerate mergers, spin-offs, project finance, and securitization.
Keywords: Bankruptcy, conglomeration, mergers, spin-offs, project finance
JEL Classification: G32, G34
Suggested Citation: Suggested Citation