Multinationals and Uncertainty: The Role of Internal Capital Markets
Jianlin Wang
Abstract
This paper studies how external lenders at the parent and subsidiary levels of an multinational enterprise (MNE) interact through its internal capital market (ICM). Due to agency problems faced by MNEs and their external lenders, I first show that an MNE can allocate an optimal portion of its external debt at the subsidiary level for delegated monitoring when local lenders have information advantages over (foreign) shareholders. Given such debt structure, I demonstrate that, when a local shock enhances the monitoring incentive of subsidiary-level external lenders, a MNE can improve its debt structure by substituting subsidiary-level external debt with parent-level external debt, without destroying the monitoring incentive. The substitution stabilizes the deleveraging pressure of the local shock as parent-level external debt tends to be cheaper. Utilizing the rise of uncertainty in the UK during an early period of Brexit as a natural experiment, I then provide detailed evidence, with data from both parent and subsidiary levels, on the substitution of external debt that stabilizes MNEs' leverage.