Intercorporate Guarantees, Leverage and Taxes

25 Pages Posted: 16 Mar 2012

See all articles by Giovanna Nicodano

Giovanna Nicodano

University of Turin - Department ESOMAS; Collegio Carlo Alberto; CEPR; EGCI; Netspar

Elisa Luciano

University of Turin - Department of Statistics and Applied Mathematics

Date Written: February 29, 2012

Abstract

This paper characterizes optimal intercorporate guarantees, under the classical trade-off between bankruptcy costs and taxation. Conditional guarantees, allowing the provider to maintain limited liability vis-à-vis the beneficiary, 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 beneficiary. This difference in optimal leverage between the provider and the beneficiary 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 and lower tax rates.

Keywords: debt, taxes, bankruptcy costs, limited liability, capital structure, subsidiary, groups, mergers

Suggested Citation

Nicodano, Giovanna and Luciano, Elisa, Intercorporate Guarantees, Leverage and Taxes (February 29, 2012). Available at SSRN: https://ssrn.com/abstract=2023542 or http://dx.doi.org/10.2139/ssrn.2023542

Giovanna Nicodano (Contact Author)

University of Turin - Department ESOMAS ( email )

Turin, 10134
Italy

HOME PAGE: http://https://www.carloalberto.org/person/giovanna-nicodano/

Collegio Carlo Alberto ( email )

Piazza Arbarello 8
Torino, Torino 10121
Italy
390116705006 (Phone)

HOME PAGE: http://https://www.carloalberto.org/person/giovanna-nicodano

CEPR ( email )

London
United Kingdom

EGCI ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Elisa Luciano

University of Turin - Department of Statistics and Applied Mathematics ( email )

Corso Unione Sovietica 218 bis
Turin, I-10122
Italy
+ 39 011 6705230 (Phone)

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
117
Abstract Views
990
Rank
425,763
PlumX Metrics