This paper explores the relationship between optimal leverage and ownership links. It develops a structural model of a parent and a subsidiary, which issues debt in its own name under a guarantee by the parent. We .nd that zero leverage can be optimal for the guarantor, while leverage close to one can be optimal for the guaranteed company, as this optimally exploits the tax shield of debt while minimizing default costs. As far as credit risk is considered, their joint default probability is lower than that of stand alone units, despite their higher debt capacity. Default probability, spreads and loss given default of the subsidiary are higher than for a stand alone with similar size and volatility. We also study the situation when the subsidiary is constrained to a debt equal to the optimal stand alone level. Only in this case group credit risk depends on the ownership share.
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Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number
69.
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