Leverage, Value And Firm Scope

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Executive Summary

This paper observes that holding-subsidiary structures (HS) provide a conditional guarantee to their lenders, and compares it to both the unconditional guarantee binding conglomerate divisions and the no-guarantee case of standalone firms. It then determines the value of their debt and equity claims, when there are bankruptcy costs and taxation in a no-arbitrage setting. The authors identify conditions ensuring higher value for HS, irrespective of diversification benefits. This stems from their higher debt capacity, in turn due to the conditional guarantee lowering bankruptcy costs, which reduces their tax burden below that of competing organizations. The value of equity in HS is however lower than in standalone organizations.

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