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Diversification discount, information rents, and internal capital markets

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  • Choe, Chongwoo
  • Yin, Xiangkang

Abstract

While many existing studies report that corporate diversification destroys shareholder value, several recent studies challenge these findings. Schoar [Schoar, A. (2002). Effects of corporate diversification on productivity. The Journal of Finance, 57, 2379-2403] finds that plants in conglomerates are more productive than those in comparable single-segment firms, although conglomerates are traded at discounts. Villalonga [Villalonga, B. (2004a). Diversification discount or premium? New evidence from the business information tracking services. The Journal of Finance, 59, 479-506; Villalonga, B. (2004b). Does diversification cause the "diversification discount". Financial Management, 33, 5-27] employs a more comprehensive database and statistical techniques than those used in the prior studies, and shows that there is a diversification premium, rather than discount. This paper develops a model that highlights the costs and benefits of corporate diversification. The diversified firm trades off the benefits of more efficient resource allocation through its internal capital market against the costs of information rents to division managers, which are necessary for effective workings of the internal capital market. We provide an argument supporting Schoar's findings, and identify conditions under which there can be a diversification discount or a premium.

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Bibliographic Info

Article provided by Elsevier in its journal The Quarterly Review of Economics and Finance.

Volume (Year): 49 (2009)
Issue (Month): 2 (May)
Pages: 178-196

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Handle: RePEc:eee:quaeco:v:49:y:2009:i:2:p:178-196

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Web page: http://www.elsevier.com/locate/inca/620167

Related research

Keywords: Diversification discount Information rents Internal capital market Multidivisional firm Single-segment firm;

References

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Citations

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Cited by:
  1. Chongwoo Choe & Tania Dey & Vinod Mishra & In-Uck Park, 2012. "Corporate Diversification, Executive Compensation, And Firm Value: Evidence From Australia," Development Research Unit Working Paper Series 36-12, Monash University, Department of Economics.
  2. Tiscini, Riccardo & Raoli, Elisa, 2013. "Stock option plan practices in family firms: The idiosyncratic private benefits approach," Journal of Family Business Strategy, Elsevier, vol. 4(2), pages 93-105.
  3. Dey, Tania & Banerjee, Rajabrata, 2011. "Can Corporate Diversification Promote Firm Value? A Survey," MPRA Paper 28928, University Library of Munich, Germany.
  4. Vinod Mishra & Rajabrata Banerjee & Tania Dey, 2011. "Influence Activity And Allocation Of Firms' Internal Capital: Evidence From Australia," Development Research Unit Working Paper Series 38-11, Monash University, Department of Economics.

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