A seminar at the Central Bank of Iceland on Thursday 12 December at 15:00. Meeting room Sölvhóll.

Speaker: Guðrún Johnsen, École Normale Supérieure

The logic of business groups: a moral hazard perspective

Abstract: A new perspective is offered on why business groups are formed. Specifically, we ask if the expectation of a government bailout lowers group-affiliated firms’ cost of capital. Using a quasi-natural experiment, we show that group-affiliated firms paid lower interest when government bailout was expected. But as soon as the bailout expectation was removed, bankers had to write down their group affiliated assets with greater likelihood, and increase the cost of capital to group-affiliated firms. As risk associated with group affiliated firms is systemically underestimated, it follows that the funding of the financial network carries a negative externality along with it.