TY - JOUR
T1 - Legal-system arbitrage and parent-subsidiary capital structures
AU - Banerjee, Suman
AU - Noe, Thomas H.
N1 - Publisher Copyright:
© 2016 INFORMS.
PY - 2017/11
Y1 - 2017/11
N2 - This paper develops a new theory of the capital structure of parent-subsidiary organizations based on legal-system arbitrage: The capital structure of parent-subsidiary organizations is chosen to minimize the agency costs generated by selective renegotiation of claims written on the component legal entities. We show that optimal mixes of parentsubsidiary- level financing minimize the default premia associated with the organization's overall financing package by equating the marginal enforceability of debt contracts written at the parent and subsidiary levels. The enforceability of creditor claims depends not only on the legal regime but also on the size of the debt claims and the liquidation value of the firm's assets. Small claims written under a weak creditor rights regime may be more enforceable than large claims written under a regime with strong creditor protection. Thus, all optimal mixes involve some borrowing at the subsidiary level even if the subsidiary legal regime features weaker creditor protection than the parent regime. However, the mix between parent and subsidiary financing tilts toward the regime that features stronger creditor protection.
AB - This paper develops a new theory of the capital structure of parent-subsidiary organizations based on legal-system arbitrage: The capital structure of parent-subsidiary organizations is chosen to minimize the agency costs generated by selective renegotiation of claims written on the component legal entities. We show that optimal mixes of parentsubsidiary- level financing minimize the default premia associated with the organization's overall financing package by equating the marginal enforceability of debt contracts written at the parent and subsidiary levels. The enforceability of creditor claims depends not only on the legal regime but also on the size of the debt claims and the liquidation value of the firm's assets. Small claims written under a weak creditor rights regime may be more enforceable than large claims written under a regime with strong creditor protection. Thus, all optimal mixes involve some borrowing at the subsidiary level even if the subsidiary legal regime features weaker creditor protection than the parent regime. However, the mix between parent and subsidiary financing tilts toward the regime that features stronger creditor protection.
KW - Capital structure
KW - Conglomerate
KW - Debt renegotiation
KW - Multinational corporation
KW - Parent-subsidiary organization
KW - Subsidiary financing
UR - http://www.scopus.com/inward/record.url?scp=85032568025&partnerID=8YFLogxK
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U2 - 10.1287/mnsc.2016.2541
DO - 10.1287/mnsc.2016.2541
M3 - Article
AN - SCOPUS:85032568025
SN - 0025-1909
VL - 63
SP - 3809
EP - 3828
JO - Management Science
JF - Management Science
IS - 11
ER -