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Intercorporate Guarantees, Leverage And Taxes

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Executive Summary

This paper characterizes optimal intercorporate guarantees, under the classical trade-off between bankruptcy costs and taxation. Conditional guarantees, allowing the guarantor - or Holding company - to maintain limited liability vis-?-vis the beneficiary - or Subsidiary - maximize joint value. They indeed achieve the highest tax savings net of default costs. The authors provide conditions ensuring that - at the optimum - guarantees increase total debt, which bears mostly on the Subsidiary. They also endogenize the choice of the guarantor, showing that it has higher proportional bankruptcy costs, lower tax rates and bigger size.

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