Beyond the Average: Coinsurance Effects and Their Dependence on Financial Constraints

Abstract

Coinsurance has differentiated effects that likely interact with financial constraints. We measure coinsurance of multi-segment firms using Granger causality between CDS spread-implied default risks of single-segment firms. Higher coinsurance results on average in lower cost of debt, higher leverage, higher cost of equity and unchanged WACC. Coinsurance lowers the cost of debt for financially unconstrained firms and increases leverage for constrained firms. Coinsurance lowers the cost of equity and the WACC only for intermediately constrained firms. Our findings indicate a wealth transfer from shareholders to debt holders and shed new light on the interplay of default risk and financial constraints.

Keywords: Default risk, corporate diversification, cost of capital, capital structure, credit default swaps

JEL Classification: G32, G33, L25