Two higher than the domestic rate (Chowdhry and

Two most important advantages
of intra-firm financing are tax deductible debt and absence of bankruptcy
costs.

The parent company has an
incentive to charge the subsidiary the higher interest rate than the one on the
market when the foreign corporate tax rate is higher than the domestic rate (Chowdhry and Nanda, 1994). but, the government
recognize this as a burden to the subsidiary and tax authorities set the limit
on the parent interest rate based on interest rates in the market that are
comparable. 

Another financing option is
two sides financing, meaning the subsidiary is financed partly by intra-firm
debt by the parent and partly by external debt. The means of financing are also
determined whether the country is bank oriented or market oriented. This
influences in the choice between public (stocks and bonds) and private
financing (bank loans) than in the amount of leverage rate (Chowdhry and Nanda,
1994). Assuming that closer monitoring and control of firm management provided
by banks should make more debt financing available in bank oriented countries
brought with it the cost of excessive bank debt. Rajan and Zingales (1995) shown
that regardless of the level of available bank debt financing in bank-oriented
countries, companies would not borrow beyond its borrowing capacity, finding
out that banks in these countries provide both debt and equity finance to firms
so the greater availability of financing does not reflect in the leverage
ratio.

Therefore, the ideal debt
financing strategy for the subsidiary is given by the balance between tax
savings due to its deductibility of interest expense and bankruptcy costs. This
balance is regulated by the priority structure of subsidiary debt, as it controls
the allowed interest rate on intra-firm debt and the bankruptcy costs
associated with external debt (Chowdhry and Nanda, 1994). These strategies
could have two separate impact: impact of increased subsidiary debt financing
and impact of reduced subsidiary debt financing.

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