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Conglomeration with bankruptcy costs: Separate or joint financing?

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Abstract

The paper analyzes the determinants of the optimal scope of incorporation in the presence of bankruptcy costs. Bankruptcy costs alone generate a non-trivial tradeoff between the benefit of coinsurance and the cost of risk contamination associated to joint financing corporate projects through debt. This tradeoff is characterized for projects with binary returns, depending on the distributional characteristics of returns (mean, variability, skewness, heterogeneity, correlation, and number of projects), the bankruptcy recovery rate, and the tax rate advantage of debt relative to equity. Our testable predictions are broadly consistent with existing empirical evidence on conglomerate mergers, spin-offs, project finance, and securitization.

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  • Albert Banal-Estañol & Marco Ottaviani, 2009. "Conglomeration with bankruptcy costs: Separate or joint financing?," Economics Working Papers 1191, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2010.
    • Handle: RePEc:upf:upfgen:1191
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    More about this item

    Keywords

    Bankruptcy; conglomeration; mergers; spin-offs; project finance;
    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
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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