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The Boundaries of the Firm: The Choice Between Stand-Alone and Integrated Firms


  • We thank Yakov Amihud, Lucian Bebchuk, Arik Ben Dor, Sugato Bhattacharyya, Mike Fishman, Paolo Fulghieri (the discussant in EFA 2000), Yaniv Grinstein, Yossi Spiegel, and seminar participants at the 2000 EFA annual meeting in London, England, Hong Kong University of Science & Technology, Northwestern University, Stockholm School of Economics, the Interdisciplinary Center Herzliya (IDC), National University Singapore, the Hebrew University, and Tel Aviv University for comments and suggestions and Nancy Kotzian for editorial assistance.


This study presents a theory of corporate structure selection. It outlines when economic units should be structured as stand-alone firms versus an integrated firm (conglomerate). The theory suggests that an integrated firm better controls agency problems through yardstick competition between managers for project acceptance. However, this structure reduces the ability to receive division-specific project information from the market. Based on this trade-off, we show that divisions within a conglomerate have different characteristics and, thus, different valuations than “similar” stand-alone firms. Our theory also explains differences in the required rate of return between stand-alone firms and conglomerates and how they relate to relative valuations of conglomerates and “similar” stand-alone firm. It also predicts when stock price reaction to divestiture and merger announcements will be positive or negative.