Do Firm Boundaries Affect Financing Policy? Evidence from Non-Financial Conglomerates with Financial Subsidiaries

Abstract

I study the capital structure of non-financial firms that own a financial subsidiary. In a panel of U.S. non-financial firms over 1984-2007 I find that a significant part of the overall Compustat non-financial universe maintains a financial subsidiary. Such non-financial firms have higher overall leverage and shorter debt maturity. However, these firms have lower excess leverage. My findings thus appear to support Diamond’s (2006, 2007) hypotheses that the establishment of a financial subsidiary in non-financial firms lowers their borrowing capacity and shortens their debt maturity due perhaps to the weaker incentives to monitor on part of the captive financial subsidiaries. Overall, these findings suggest that firm boundaries are an important factor to determine corporate financing policy. They also highlight an additional cost associated with internal capital markets, namely, the diminished borrowing capacity and shortened debt maturity for non-financial borrowers in internal capital markets.