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Subsidiary Financing: Risk Shifting as a Commitment Device

Author

Listed:
  • Gyöngyi Loranth

  • Alan D. Morrison
  • Jing Zeng

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.

Suggested Citation

  • Gyöngyi Loranth & Alan D. Morrison & Jing Zeng, 2026. "Subsidiary Financing: Risk Shifting as a Commitment Device," CRC TR 224 Discussion Paper Series crctr224_2025_770, University of Bonn and University of Mannheim, Germany.
    • Handle: RePEc:bon:boncrc:crctr224_2025_770
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    File URL: https://www.crctr224.de/research/discussion-papers/archive/dp770
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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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