Debt Boundaries Matter: Evidence from the Subsidiary Debt

Abstract

I use an accounting reform to assess the agency cost of debt in diversified firms. Firms that switch from single-to-multisegment following the reform suffer a 12% increase in the bond spread than their standalone peers. Consistent with lenders anticipating underinvestment and asset substitution incentives, diversified firms with a high cash flow volatility across divisions suffer the highest increase in borrowing costs. I employ a novel approach that allows abstracting from unobservable characteristics that would otherwise influence the pricing of diversified firms' debt.