Bankruptcy in Groups

Abstract:     

We examine bankruptcy within business groups. Groups have incentives to support financially distressed subsidiaries as the bankruptcy of a subsidiary may impose severe costs for the group as a whole. In several countries around the world, bankruptcy courts often “pierce the corporate veil” and hold groups liable for their distressed subsidiaries’ obligations as if these were their own. Using a large cross-country sample of group-affiliated firms, we show that, by re-shuffling resources within the group structure, business groups actively manage intra-group credit risk. The pattern of capital reallocation appears consistent with groups seeking to prevent veil piercing in that preferential support is offered to subsidiaries whose insolvencies are expected to be more costly. Moreover, we find that large and diversified groups are more effective at insulating their subsidiaries from credit-risk shocks. Further, we document that recent regulatory changes on approval and disclosure of related-party transactions may limit groups’ ability to insulate their subsidiaries from credit-risk shocks, especially if stricter regulation is not accompanied by improved access to external capital markets.

Number of Pages in PDF File: 75

Keywords: Bankruptcy, Credit Risk, Business Groups, Subsidiaries, Veil Piercing, Related-Party Transactions, Regulation

JEL Classification: G14, G15, G38, M41, M48