Limited liability in business groups

Eva Ropero Moriones

DEE - Working Papers. Business Economics. WB from Universidad Carlos III de Madrid. Departamento de Economía de la Empresa

Abstract: We consider a model in which a holding company has to decide whether to finance an investment project in a subsidiary. The project can be financed either through internal capital or through debt. The subsidiary's manager has private information on the quality of the project and has empirebuilding preferences. When bankruptcy is costly for the subsidiary's manager, the choice between internal and external financing is part of an optimal mechanism that induces truthful revelation of the information. The first best solution can be approached if the cost of bankruptcy for the manager is high enough.

Date: 2005-12
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