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Subsidiary Financing: Risk Shifting as a Commitment Device

Author

Listed:
  • Gyöngyi Lóránth

    (University of Vienna & CEPR)

  • Alan D. Morrison

    (Saïd Business School, University of Oxford, CEPR, & ECGI)

  • Jing Zeng

    (University of Bonn & CEPR)

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.

Suggested Citation

  • Gyöngyi Lóránth & Alan D. Morrison & Jing Zeng, 2026. "Subsidiary Financing: Risk Shifting as a Commitment Device," ECONtribute Discussion Papers Series 423, University of Bonn and University of Cologne, Germany.
    • Handle: RePEc:ajk:ajkdps:423
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    File URL: https://www.econtribute.de/RePEc/ajk/ajkdps/ECONtribute_423_2026.pdf
    File Function: First version, 2026
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    More about this item

    Keywords

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    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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