Valuation of parent guarantees of subsidiary debt: Ownership, risk and leverage implications
Journal
Pacific-Basin Finance Journal
Journal Volume
2
Journal Issue
4
Pages
391-404
Date Issued
1994
Author(s)
Abstract
The dramatic economic growth in the emerging Southeast Asian economies has prompted numerous multi-national corporations to establish subsidiaries through joint ventures in the Pacific Rim. Although the parent and the subsidiary are legally distinct, the latter's viability often critically depends on the implicit guarantee of its debt and other financial committments provided by the parent corporation. However, despite their wide use and growing importance, such implicit guarantees have not been previously formally analyzed. We do so in a contingent-claims framework and obtain four main results: (i) the implicit guarantee's value; (ii) the parent and subsidiary shareholders' incentives for establishing a joint venture; (iii) the parent's minimum viable equity stake in the subsidiary and the impact of changes in the subsidiary's business risk and financial leverage on the parent's equity stake in its subsidiary; and (iv) the impact of such implicit guarantees on the parent's optimal financial leverage and asset risk choices. © 1994.
SDGs
Type
journal article