Philipp N. Baecker () (Department of Finance and Accounting, EUROPEAN BUSINESS SCHOOL (ebs), International University Schloß Reichartshausen) Gunnar Grass () (Department of Finance and Accounting, EUROPEAN BUSINESS SCHOOL (ebs), International University Schloß Reichartshausen)
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Using US stock market panel data from 1999 to 2004 we examine the relationship between diversification effects predicted by the classic Merton (1970) model of capital structure on the one hand and the conglomerate discount resulting from comparable company analysis as initially proposed by Berger and Ofek (1995) on the other. Improving upon previous research, the explicit calculation of equity values by means of contingent-claims analysis allows us to capture the non-linear relationship predicted by theory in a random-effects regression model. Results support the hypothesis put forth by Mansi and Reeb (2002), according to which part of the observed discount is actually due to a transfer of wealth from shareholders to bondholders, in other words "reverse asset substitution." However, for the majority of firms in the sample, the destruction of shareholder value induced by risk reduction is much lower than commonly expected. Firms and investors alike should therefore be cautioned against attributing significant discounts to financial effects detached from underlying economic issues alone.
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Paper provided by Department of Finance and Accounting, EUROPEAN BUSINESS SCHOOL (ebs), International University Schloß Reichartshausen in its series ebs Working Papers on Finance and Accounting with number
070101.
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