Captive Finance Subsidiaries and the M-Form Hypothesis

Williamson's theory of hierarchy is used to show that the widespread and, before now, unexplained corporate practice of establishing captive finance subsidiaries may be understood as an instance of multidivisonal-form reorganization. It is argued that such reorganization enhances internal efficiency and eases the monitoring task of lenders, thus facilitating borrowing. The debt ratios of firms in five U.S. industries are examined and the evidence, while not conclusive, provides support for the hypothesis. Thinking of captive finance subsidiaries in terms of the theory of hierarchy is consistent with the rationale for finance subsidiaries presented by corporate officers.