Ownership Links, Leverage and Credit Risk

Abstract

This paper explores the relationship between optimal leverage and credit risk under ownership links. It develops a structural model of a parent and a subsidiary, which issues debt in its own name under a guarantee by the parent. We …nd that zero leverage can be optimal for the guarantor, while leverage close to one can be optimal for the guaranteed company, as this optimally exploits the tax shield of debt while minimizing default costs. As far as credit risk is considered, their joint default probability is lower than that of stand alone units, despite their higher debt capacity. Higher group optimal leverage and lower default probability increase value with respect to conglomerate mergers and stand alone arrangements. Default probability, spreads and loss given default of the subsidiary are higher than for a stand alone with similar size and volatility.We also study the situation when the subsidiary is constrained to a debt equal to the optimal stand alone level. Only in this case group credit risk depends on the ownership share.Consistently with intuition, our unconstrained model rationalizes the capital structure typical of private equity; the constrained model instead is able to explain observed features of public business groups and more regulated environments.

Propping in the Pyramidal Business Groups in Turkey

“…The articles by Bianco and Nicodano ( ), Luciano and Nicodano ( ), and Luciano and Nicodano ( ) focus on optimal debt allocation across business group‐affiliated companies and investigate whether group affiliation affects the distribution of leverage across companies. They found that parent subsidiaries are value increasing relative to stand‐alone firms because the guarantees have self‐enforcement potential.…”

The Simulation Study on the Control of Credit Risk of the Enterprise Group Based on the Intensity of Affiliated Transactions

“…However, with the continuous expansion of the intensity of the of the related party transactions, the negative impact would gradually be revealed, such as the internal related party transactions was more difficult to control, and regulatory cost more. Under this set of parameters, when the intensity of the related relationship was during [5,7], the Enterprise Group's overall credit risk was controlled at a lower level, and no doubt, this was suitable for the development of the enterprise Group.…”

“…(2005) thought that the enterprise Group's internal capital market could be seen as a risk-sharing mechanism, which led to the delay of the credit risk exposure [4]. Luciano and Nicodano (2008), studied the relationship between the ownership structure of the enterprise Group and credit risk through empirical research [5]. Chen Lin and Zhou (2009) built the links between the enterprises within Enterprise Group by equity ratio [6,7].…”