DEFINITION of 'Co-insurance Effect'

A theory on corporate debt that posits that the likelihood of default decreases when two firms' assets and liabilities are combined through a merger or acquisition compared to the likelihood of default in the individual companies. The co-insurance effect relates to the concept of diversification, as risky debt is spread across the new firm's operations.

BREAKING DOWN 'Co-insurance Effect'

If the co-insurance effect is true, firms that merge may experience financial synergies through combining operations. Furthermore, the combined debt should be safer than before, which should reduce the yield investors demand from the corporation's bonds. This can reduce the cost of issuing new debt for the company, making it cheaper to raise additional funds.

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