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Default risk in business groups

Author

Listed:
  • Elisa Luciano
  • Giovanna Nicodano

Abstract

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.

Suggested Citation

  • Elisa Luciano & Giovanna Nicodano, 2012. "Default risk in business groups," Carlo Alberto Notebooks 283, Collegio Carlo Alberto.
    • Handle: RePEc:cca:wpaper:283
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    File URL: https://www.carloalberto.org/wp-content/uploads/2018/11/no.283.pdf
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    References listed on IDEAS

    as
    1. Sarig, Oded H., 1985. "On Mergers, Divestments, and Options: A Note," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(3), pages 385-389, September.
    2. Gil S. Bae & Youngsoon S. Cheon & Jun-Koo Kang, 2008. "Intragroup Propping: Evidence from the Stock-Price Effects of Earnings Announcements by Korean Business Groups," The Review of Financial Studies, Society for Financial Studies, vol. 21(5), pages 2015-2060, September.
    3. Gregor Andrade & Steven N. Kaplan, 1998. "How Costly is Financial (Not Economic) Distress? Evidence from Highly Leveraged Transactions that Became Distressed," Journal of Finance, American Finance Association, vol. 53(5), pages 1443-1493, October.
    4. Michael C. Jensen, 1991. "Corporate Control And The Politics Of Finance," Journal of Applied Corporate Finance, Morgan Stanley, vol. 4(2), pages 13-34, June.
    5. 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.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Elisa Luciano & Clas Wihlborg, 2013. "The Organization of Bank Affiliates; A Theoretical Perspective on Risk and Efficiency," ICER Working Papers 06-2013, ICER - International Centre for Economic Research.
    2. Elisa Luciano & Clas Wihlborg, 2013. "Financial synergies and the Organization of Bank Affiliates; A Theoretical Perspective on Risk and Efficiency," Carlo Alberto Notebooks 322, Collegio Carlo Alberto, revised 2014.

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    More about this item

    Keywords

    credit risk; structural models; groups; mergers; parent- subsidiary.;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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