Abstract
The limited liability of group affiliated firms provides the group with an option of partial liquidation which has positive effects on the survival of groups. The option of partial liquidation also has a negative effect on the incentives of the parent firm (and ultimately the controlling shareholders). It exacerbates the asset substitution problem. Lenders being aware of this problem can be expected to require higher interest rates from group affiliated firms. One way, however, for the parent firm to commit to not taking advantage of partial liquidation is by placing more debt at the top of the group. I investigate the placement of debt in formal corporate groups in which the parent firms have very high ownership stakes in their subsidiaries. I argue that such firms have very high incentive to place debt strategically. I find the parent firms in my sample do indeed have higher leverage than their subsidiaries. The difference is not very large, however. Closer inspection reveals that the complexity and transparency of the group are very important influences on how debt is placed within groups. The size of the group and the amount of intra-group debt within the group are substantial negative influences on subsidiary debt. This is taken as indication that lenders in this situation face reduced transparency and cannot be sure where the funds they lend end up within the group.