Subsidiary Financing: Risk Shifting as a Commitment Device

Gyöngyi Loranth (), Alan D. Morrison and Jing Zeng ()

CRC TR 224 Discussion Paper Series from University of Bonn and University of Mannheim, Germany

Abstract: Westudy how firms can design their organizational structures to overcome dynamic commitment problems when entering new markets. A manager exerts 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. Sub sidiaries are most valuable for projects that are costly to develop, have moderate man agement 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
Date: 2026-07
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