The Use of Financial Contracting Arrangements to Constrain Rent-Seeking Behaviour of Managers of Subsidiary Firms: Evidence from UK and US Multinational Subsidiary Firms

Abstract

We propose and test two hypotheses on how multinational (MNC) parents can use different financial contracting arrangements when financing their subsidiaries in order to constrain the rent-seeking behavior of subsidiary management. Furthermore, we also examine how the MNC parent can effectively enhance the monitoring of their subsidiaries by delegating this function to external financial institutions. One hypothesis analyses the use of short-term debt. The second hypothesis investigates the use of short-term external debt. Moreover, our analysis is enriched by investigating these two hypotheses in two different settings, namely by comparing between UK domestic and UK subsidiary firms and by comparing UK and US subsidiary firms. This enables us to measure the subsidiary effect and the location/distance effect. Using an unbalanced panel data of 11762 and 10096 firm-year observations we find that UK subsidiaries have more short-term debt and more short-term external debt compared to equivalent UK domestic firms and that US subsidiaries have more short-term debt and less short-term external debt compared to equivalent UK subsidiaries. Our results are both statistically and economically significant. We find these results in spite of our domestic firms being larger, being more profitable, having higher growth opportunities, and having higher tangibility, all factors which should translate in higher amounts of debt. Our results are robust, even after controlling for all the variables that have been found to affect leverage in the literature and when we use a matched sample approach to test our hypotheses. Furthermore, we also consider and rule out other possible explanations for our results.