Is there Really No Conglomerate Discount?

Authors

  • Manuel Ammann,

    1. The first author is from the Swiss Institute of Banking and Finance, University of St. Gallen, Switzerland. The second author is from the Department of Finance, University of Basel, Switzerland and Man Investments, Pfaeffikon, CH-8808, Switzerland. The third author is from the University of Mannheim, Finance Area, Germany. They are grateful to an anonymous referee, Yakov Amihud, Aswath Damodaran, Markus Glaser, Gunnar Grass, David Oesch, Urs Peyer, Peter Pope (editor), Nagpurnanand Prabhala, Stephan Suess, Gabrielle Wanzenried, Marco Wilkens, Evert Wipplinger, and seminar participants at the University of Bayreuth, the University of St. Gallen, the 2008 Conference of the Swiss Society for Financial Market Research in Zurich, and the 2008 Symposium on Finance, Banking, and Insurance at the University of Karlsruhe for helpful comments and discussions. All errors are the authors'.
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  • Daniel Hoechle,

    1. The first author is from the Swiss Institute of Banking and Finance, University of St. Gallen, Switzerland. The second author is from the Department of Finance, University of Basel, Switzerland and Man Investments, Pfaeffikon, CH-8808, Switzerland. The third author is from the University of Mannheim, Finance Area, Germany. They are grateful to an anonymous referee, Yakov Amihud, Aswath Damodaran, Markus Glaser, Gunnar Grass, David Oesch, Urs Peyer, Peter Pope (editor), Nagpurnanand Prabhala, Stephan Suess, Gabrielle Wanzenried, Marco Wilkens, Evert Wipplinger, and seminar participants at the University of Bayreuth, the University of St. Gallen, the 2008 Conference of the Swiss Society for Financial Market Research in Zurich, and the 2008 Symposium on Finance, Banking, and Insurance at the University of Karlsruhe for helpful comments and discussions. All errors are the authors'.
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  • Markus Schmid

    Corresponding author
    1. The first author is from the Swiss Institute of Banking and Finance, University of St. Gallen, Switzerland. The second author is from the Department of Finance, University of Basel, Switzerland and Man Investments, Pfaeffikon, CH-8808, Switzerland. The third author is from the University of Mannheim, Finance Area, Germany. They are grateful to an anonymous referee, Yakov Amihud, Aswath Damodaran, Markus Glaser, Gunnar Grass, David Oesch, Urs Peyer, Peter Pope (editor), Nagpurnanand Prabhala, Stephan Suess, Gabrielle Wanzenried, Marco Wilkens, Evert Wipplinger, and seminar participants at the University of Bayreuth, the University of St. Gallen, the 2008 Conference of the Swiss Society for Financial Market Research in Zurich, and the 2008 Symposium on Finance, Banking, and Insurance at the University of Karlsruhe for helpful comments and discussions. All errors are the authors'.
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Markus Schmid, University of Mannheim, Finance Area, Chair for Business Administration and Corporate Governance, D-68131 Mannheim, Germany. e-mail: schmid@bwl.uni-mannheim.de

Abstract

Abstract:  Recent research questions the existence of a conglomerate discount. This study addresses two of the most important explanations for the conglomerate discount and finds evidence in support of an economically and statistically significant discount. The first explanation is that the risk-reducing effect of diversification increases debt value and consequently the use of the book value of debt leads to an underestimation of firm value in diversified firms. We show that the effect of using an imputed market value of debt reduces the conglomerate discount only by a small fraction. However, consistent with the value-transfer hypothesis, we find the discount to increase in leverage and no discount for all-equity firms. An agency cost-based explanation, which reconciles these conflicting findings, is that managers in levered firms become aligned with creditors and reduce firm risk at the expense of shareholders. Hence, the diversification discount only occurs in levered firms and stems from conflicts of interest between managers and shareholders over corporate risk taking. Second, the conglomerate discount may emerge from a neglect of the endogenous nature of the diversification decision. We first show that the conglomerate discount in fact disappears when we account for endogeneity in a Heckman selection model. However, when we account for fixed effects, the conglomerate discount remains statistically and economically significant, also in a Heckman selection-model or instrumental variables framework.

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