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Intercorporate guarantees, leverage and taxes


  • Elisa Luciano
  • Giovanna Nicodano


This paper characterizes optimal intercorporate guarantees, under the classical trade-off between bankruptcy costs and taxation. Conditional guarantees, allowing the guarantor - or Holding company - to maintain limited liability vis-a-vis the beneficiary - or Subsidiary - maximize joint value. They indeed achieve the highest tax savings net of default costs. We provide conditions ensuring that - at the optimum - guarantees increase total debt, which bears mostly on the Subsidiary. This difference in optimal leverage between Holding company and Subsidiary explains why optimal conditional guarantees (i) generate value independently of cash flow correlation (ii) are unilateral rather than mutual, at least for moderate default costs (iii) dominate the unconditional ones, that are embedded in mergers, at least when firms have high cash-flow correlation. We also endogenize the choice of the guarantor, showing that it has higher proportional bankruptcy costs, lower tax rates and bigger size.

Suggested Citation

  • Elisa Luciano & Giovanna Nicodano, 2008. "Intercorporate guarantees, leverage and taxes," Carlo Alberto Notebooks 95, Collegio Carlo Alberto, revised 2010.
  • Handle: RePEc:cca:wpaper:95

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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.

    More about this item


    debt; taxes; bankruptcy costs; limited liability; capital structure; subsidiary; groups; mergers;

    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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