Why Do Parent Companies Guarantee Their Subsidiaries’ Bonds? The Dark Side of Separate Legal Liability

49 Pages Posted: 10 Oct 2016 Last revised: 22 Feb 2019

See all articles by Michela Altieri

Michela Altieri

Vrije Universiteit Amsterdam

Alberto Manconi

Bocconi University - Department of Finance; Centre for Economic Policy Research (CEPR)

Massimo Massa

INSEAD - Finance

Date Written: October 17, 2016

Abstract

Parent guarantees to subsidiary bond issues can circumvent restrictive covenants on parent debt, and transfer wealth from bond- to equity-holders or maximize parent managers’ private benefits. We find that parent firms expecting stringent covenants on their own debt more likely guarantee subsidiary bonds, and less likely when the pressure from covenants attenuates. Parent bond and stock prices drop after guaranteed subsidiary bond issues. Following such issues parents do not increase payout or risk, but more likely undertake acquisitions. These results suggest that the benefits of limited liability are balanced by the potential agency costs that it creates.

Keywords: bond returns; bond guarantees; subsidiary firms; financial flexibility

JEL Classification: G11, G14, G23

Suggested Citation

Altieri, Michela and Manconi, Alberto and Massa, Massimo, Why Do Parent Companies Guarantee Their Subsidiaries’ Bonds? The Dark Side of Separate Legal Liability (October 17, 2016). INSEAD Working Paper No. 2016/72/FIN. Available at SSRN: https://ssrn.com/abstract=2849420 or http://dx.doi.org/10.2139/ssrn.2849420

Michela Altieri (Contact Author)

Vrije Universiteit Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

Alberto Manconi

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

HOME PAGE: http://mypage.unibocconi.eu/albertomanconi/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Massimo Massa

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
+33 1 6072 4481 (Phone)
+33 1 6072 4045 (Fax)

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