Diversification with Bankruptcy costs: the good, the bad and the ugly

Research Seminars

According to the conventional wisdom in corporate finance, expected bankruptcy costs are reduced when projects are financing jointly rather than separately. In this paper, we argue that the same logic that generates the diversification synergies of joint financing also generates dissynergies in some cases. By exploiting a connection with the industrial organization literature on product bundling, we characterize conditions for diversification to increase (rather than reduce) the probability of bankruptcy. We also identify situations in which it is optimal for a firm to finance two projects separately, even though joint finance would result in a lower interest rate.





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