DP11992 Corporate Bond Guarantees and The Value of Financial Flexibility

Author(s): Michela Altieri, Alberto Manconi, Massimo Massa
Publication Date: April 2017
Keyword(s): bond guarantees, bond returns, financial flexibility, subsidiary firms
JEL(s): G11, G14, G23
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11992

We examine the effects of the decision of parent companies to guarantee bonds issued by their subsidiaries. The market value of the parent firm's outstanding bonds drops two times more when it issues a guarantee for subsidiary debt than when it issues a new bond in its own name. This effect is exacerbated when the parent is financially constrained, or when its bonds are less liquid. Subsidiary guaranteed debt has less stringent covenant protection, and a longer maturity, consistent with subsidiary guaranteed debt providing greater flexibility to the parent. Our estimates imply a value of financial flexibility, measured as the difference in the impact on bond yield spreads between parent and subsidiary guaranteed bonds, of about 30 bps.