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Default risk in business groups

  • Elisa Luciano
  • Giovanna Nicodano

This paper analyzes how combining firms into either groups or conglomerates affects their credit standing, as measured by their de- fault probabilities, recovery rates and credit spreads. Each combina- tion offers protection against default to its affiliates, and issues debt to optimize the trade-off between tax gains and default costs. In a group, the probability of joint default turns out to be lower than that of both stand-alone firms and conglomerates. This is the bright side of credit risk in groups. The dark side is that affiliation depletes the credit worthiness of the subsidiary. Such results hold irrespective of cash- ow correlation, if affiliates are equal in size, but fade if the parent is larger.

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File URL: http://www.carloalberto.org/assets/working-papers/no.283.pdf
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Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 283.

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Length: 27 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:cca:wpaper:283
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  1. Tykvová, Tereza & Borell, Mariela, 2012. "Do private equity owners increase risk of financial distress and bankruptcy?," Journal of Corporate Finance, Elsevier, vol. 18(1), pages 138-150.
  2. Michael C. Jensen, 1991. "Corporate Control And The Politics Of Finance," Journal of Applied Corporate Finance, Morgan Stanley, vol. 4(2), pages 13-34.
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