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Short-Sales Constraints and the Diversification Puzzle

Author

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  • Adam V. Reed

    (Kenan-Flagler Business School, University of North Carolina, Chapel Hill, North Carolina 27599)

  • Pedro A. C. Saffi

    (Judge Business School, University of Cambridge, Cambridge CB2 1AG, United Kingdom)

  • Edward D. Van Wesep

    (Leeds School of Business, University of Colorado Boulder, Boulder, Colorado 80309)

Abstract

Disagreement about stock valuation, combined with short-sales constraints, can increase asset prices. We build a model showing that, so long as investor beliefs are not perfectly correlated, investors disagree less about the value of a conglomerate than about each of its individual divisions. This generates a conglomerate discount with disagreement and short-sales constraints being complementary in explaining its cross-sectional variation. We test these predictions empirically and find substantial support: conglomerates have lower differences of opinion and lower short-sales constraints than pure-play firms. Furthermore, greater differences of opinion and tighter short-sales constraints are significant predictors of valuation differences between conglomerates and pure plays. This paper was accepted by Karl Diether, finance.

Suggested Citation

  • Adam V. Reed & Pedro A. C. Saffi & Edward D. Van Wesep, 2021. "Short-Sales Constraints and the Diversification Puzzle," Management Science, INFORMS, vol. 67(2), pages 1159-1182, February.
    • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:2:p:1159-1182
    DOI: 10.1287/mnsc.2019.3467
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    References listed on IDEAS

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