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What Do We Know About Cross-subsidization? Evidence from Merging Firms

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  • Chevalier Judith

    ()
    (Yale University)

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    Abstract

    A substantial empirical literature documents value-destroying “cross-subsidization” among the divisions of diversified firms. However, this literature relies upon two maintained hypotheses: that divisions of diversified firms are randomly allocated to their corporate parents and that the investment opportunities facing conglomerate divisions are identical to those of stand-alone firms in their industries. I examine the investment behavior prior to merger of a sample of firms that undertook diversifying mergers between 1980 and 1995. I show that, in my sample, investment patterns that the literature has attributed to cross-subsidization between divisions are apparent in the pairs of merging firms prior to their mergers. Thus, some of the cross-subsidization results in the literature may be attributable to selection bias. I also examine stock market responses to announcements of diversifying acquisitions. The event responses are largely independent of measures of the extent to which the merger is diversifying.

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    Bibliographic Info

    Article provided by De Gruyter in its journal The B.E. Journal of Economic Analysis & Policy.

    Volume (Year): 4 (2004)
    Issue (Month): 1 (April)
    Pages: 1-29

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    Handle: RePEc:bpj:bejeap:v:advances.4:y:2004:i:1:n:3

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    Cited by:
    1. Yan, An & Yang, Zaihui & Jiao, Jie, 2010. "Conglomerate investment under various capital market conditions," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(1), pages 103-115, January.
    2. Wulf, Julie, 2009. "Influence and inefficiency in the internal capital market," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 72(1), pages 305-321, October.
    3. Agarwal, Sumit & Chiu, I-Ming & Souphom, Victor & Yamashiro, Guy M., 2011. "The efficiency of internal capital markets: Evidence from the Annual Capital Expenditure Survey," The Quarterly Review of Economics and Finance, Elsevier, Elsevier, vol. 51(2), pages 162-172, May.
    4. Seru, Amit, 2014. "Firm boundaries matter: Evidence from conglomerates and R&D activity," Journal of Financial Economics, Elsevier, Elsevier, vol. 111(2), pages 381-405.
    5. Axel, GAUTIER & Malika, HAMADI, 2005. "Internal Capital Market Efficiency of Belgian Holding Companies," Discussion Papers (ECON - Département des Sciences Economiques), Université catholique de Louvain, Département des Sciences Economiques 2004037, Université catholique de Louvain, Département des Sciences Economiques.
    6. Stefan Erdorf & Thomas Hartmann-Wendels & Nicolas Heinrichs & Michael Matz, 2013. "Corporate diversification and firm value: a survey of recent literature," Financial Markets and Portfolio Management, Springer, Springer, vol. 27(2), pages 187-215, June.
    7. Glaser, Markus & Müller, Sebastian, 2010. "Is the diversification discount caused by the book value bias of debt?," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(10), pages 2307-2317, October.
    8. Ekaterina Emm & Jayant Kale, 2006. "Efficiency Implications of Corporate Diversification: Evidence from Micro Data," Working Papers 06-26, Center for Economic Studies, U.S. Census Bureau.
    9. Choe, Chongwoo & Yin, Xiangkang, 2009. "Diversification discount, information rents, and internal capital markets," The Quarterly Review of Economics and Finance, Elsevier, Elsevier, vol. 49(2), pages 178-196, May.
    10. Glaser, Markus & Müller, Sebastian, 2006. "Der Diversification Discount in Deutschland: Existiert ein Bewertungsabschlag für diversifizierte Unternehmen?," Sonderforschungsbereich 504 Publications, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim 06-13, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
    11. Chen, Sheng-Syan & Chen, I-Ju, 2012. "Corporate governance and capital allocations of diversified firms," Journal of Banking & Finance, Elsevier, Elsevier, vol. 36(2), pages 395-409.
    12. Masson, Robert & Tookes, Heather & Um, Taejong, 2009. "Firm diversification and equilibrium risk pooling: The Korean financial crisis as a natural experiment," Emerging Markets Review, Elsevier, Elsevier, vol. 10(1), pages 1-22, March.

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