Two higher than the domestic rate (Chowdhry and

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Last updated: September 13, 2019

Two most important advantagesof intra-firm financing are tax deductible debt and absence of bankruptcycosts.

The parent company has anincentive to charge the subsidiary the higher interest rate than the one on themarket when the foreign corporate tax rate is higher than the domestic rate (Chowdhry and Nanda, 1994). but, the governmentrecognize this as a burden to the subsidiary and tax authorities set the limiton the parent interest rate based on interest rates in the market that arecomparable.  Another financing option istwo sides financing, meaning the subsidiary is financed partly by intra-firmdebt by the parent and partly by external debt. The means of financing are alsodetermined whether the country is bank oriented or market oriented. Thisinfluences in the choice between public (stocks and bonds) and privatefinancing (bank loans) than in the amount of leverage rate (Chowdhry and Nanda,1994).

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Assuming that closer monitoring and control of firm management providedby banks should make more debt financing available in bank oriented countriesbrought with it the cost of excessive bank debt. Rajan and Zingales (1995) shownthat regardless of the level of available bank debt financing in bank-orientedcountries, companies would not borrow beyond its borrowing capacity, findingout that banks in these countries provide both debt and equity finance to firmsso the greater availability of financing does not reflect in the leverageratio.Therefore, the ideal debtfinancing strategy for the subsidiary is given by the balance between taxsavings due to its deductibility of interest expense and bankruptcy costs. Thisbalance is regulated by the priority structure of subsidiary debt, as it controlsthe allowed interest rate on intra-firm debt and the bankruptcy costsassociated with external debt (Chowdhry and Nanda, 1994).

These strategiescould have two separate impact: impact of increased subsidiary debt financingand impact of reduced subsidiary debt financing.

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