Coinsurance and the Corporate Cost of Capital
71 Pages Posted: 6 Nov 2018 Last revised: 11 Apr 2019
Date Written: April 10, 2019
We empirically examine how coinsurance induced by diversification affects a firm’s cost of capital and its key determinants. Our newly developed coinsurance measure explicitly captures the default risk connectedness across a firm’s business segments and hence the very source of coinsurance. We find that firms with higher coinsurance display a lower cost of debt or higher leverage, with the chosen trade-off predictably varying with a firm’s financial constraint. Coinsured firms exhibit a higher cost of equity, except those with intermediate financial constraints. Overall, coinsurance relates to a lower cost of capital for the latter. Highly constrained firms face a markup.
Keywords: diversification, coinsurance, cost of capital, default risk connectedness, financial constraint
JEL Classification: G32, G33, L25
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