Legal-System Arbitrage and Parent–Subsidiary Capital Structures

Suman Banerjee () and Thomas H. Noe ()
Additional contact information
Suman Banerjee: University of Wyoming, Laramie, Wyoming 82071
Thomas H. Noe: Saïd Business School and Balliol College, University of Oxford, Oxford OX1 3BJ, United Kingdom

Management Science, 2017, vol. 63, issue 11, 3809-3828

Abstract: 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 parent-subsidiary–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.

Keywords: conglomerate; capital structure; debt renegotiation; multinational corporation; parent–subsidiary organization; subsidiary financing (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://doi.org/10.1287/mnsc.2016.2541 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:63:y:2017:i:11:p:3809-3828

Access Statistics for this article

More articles in Management Science from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().