Complex Organizations, Leverage, and Interest Rates

Our trade-off model studies optimal leverage responses to interest rates within a sponsor–backed unit structure. This setup captures organizational forms-including private equity, parent–subsidiary, and securitization arrangements- in which a sponsor provides contingent support to an affiliated unit. When interest rates fall below a cutoff, the sponsor chooses zero leverage, while the backed unit increases borrowing. Unlike stand-alone firms, whose leverage declines monotonically as interest rates fall, backed units generate higher expected default costs in low-interest-rate environments. Our results show how complex organizations can reallocate leverage toward less constrained entities, highlighting a new governance channel shaping borrowing decisions.