Guarantees, Leverage, and Taxes
Forthcoming, Review of Financial Studies
Posted: 28 Feb 2014 Last revised: 3 Jul 2017
Date Written: February 28, 2014
Abstract
This paper considers the optimal joint decision on firm organization and capital structure under a tax-bankruptcy trade-off, stressing the role of guarantees against default. Conditional guarantees, which are embedded in parent-subsidiary structures, increase joint value and joint debt relative to unguaranteed stand-alone firms. Such guarantees, that are unilateral rather than mutual for moderate default costs, may dominate the unconditional mutual guarantees built in mergers. We study the optimal characteristics of both guarantors and beneficiaries, as well as their impact on the self-enforcement potential of conditional guarantees.
Keywords: bailout, debt, bankruptcy costs, capital structure, groups, mergers, subsidiary, limited liability.
JEL Classification: G32, G34, L22.
Suggested Citation: Suggested Citation