Leverage and Value Creation in Holding-Subsidiary Structures

Leverage and Value Creation in Holding-Subsidiary Structures

Elisa Luciano, Giovanna Nicodano

Series number :

Serial Number: 
268/2009

Date posted :

December 01 2009

Last revised :

December 09 2009
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Keywords

  • holding • 
  • subsidiary • 
  • groups • 
  • guarantees • 
  • debt • 
  • taxes • 
  • bankruptcy costs • 
  • limitedliability • 
  • capital structure

This paper determines optimal capital structure and value of Holding-Subsidiary structures (HS), when there is a trade-off between bankruptcy costs and taxation. HS have higher firm value than their stand alone counterparts, as the holding provides a guarantee to its subsidiary’s lenders which lowers expected bankruptcy costs, at a given debt level.

HS may also reach higher debt capacity, which further increases their value by reducing the tax burden below that of stand alone firms. Optimal debt in the holding and in the subsidiary are respectively lower and higher than in their stand-alone counterparts. Such debt diversity preserves the holding ability to rescue its subsidiary, hence value creation by HS, even with perfect cash flow correlation.

Authors

Real name: 
Elisa Luciano