Bankruptcy in Groups

Abstract

We examine bankruptcy within business groups. Groups have incentives to support financially distressed subsidiaries, as the bankruptcy of a subsidiary may impose severe costs on the group as a whole. This is in part because, in several countries, bankruptcy courts often “pierce the corporate veil” and hold groups liable for their distressed subsidiaries’ obligations as if they were their own. Using a large cross-country sample of group-affiliated firms, we show that, by reallocating resources within the corporate structure, business groups actively manage intra-group credit risk to prevent costly within-group insolvencies. Moreover, we document that recent regulatory changes in the approval and disclosure of related party transactions are costly for business groups in that they constrain their ability to shield their subsidiaries from credit-risk shocks. Our study informs the current regulatory debate on related party transactions by highlighting an important cost of anti-self-dealing regulation.