Subsidiary Financing: Risk Shifting as a Commitment Device

Gyöngyi Lóránth (), Alan D. Morrison () and Jing Zeng ()
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Gyöngyi Lóránth: University of Vienna & CEPR
Alan D. Morrison: Saïd Business School, University of Oxford, CEPR, & ECGI
Jing Zeng: University of Bonn & CEPR

No 423, ECONtribute Discussion Papers Series from University of Bonn and University of Cologne, Germany

Abstract: We study how firms can design their organizational structures to overcome dynamic commitment problems when entering new markets or technologies. A manager must exert costly effort to first develop and subsequently manage an investment opportunity. Ex post, the firm underinvests in projects that generate high management rents. However, the prospect of those rents helps offset the manager’s initial project development cost, making ex ante commitment to invest optimal. Levered subsidiaries mitigate this time-consistency problem by introducing risk-shifting incentives that counteract underinvestment. Subsidiaries are most valuable for projects that are costly to develop, have moderate management costs, and yield returns uncorrelated with existing business.

Keywords: Organizational structure; investment strategy; branch; subsidiary (search for similar items in EconPapers)
JEL-codes: G32 G34 L22 (search for similar items in EconPapers)
Pages: 69 pages
Date: 2026-07
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