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Diversification and Delegation in Firms

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  • Sonja Daltung
  • Vittoria Cerasi

Abstract

This paper shows how separation of ownership and control may arise as a response to overload costs, despite agency costs, and how conglomerates arise as solution to information asymmetries in capital markets. In a context where entrepreneurs have the ability to run projects and improve their future cash flow, there could be rationing of credit due to moral hazard between entrepreneurs and investors. Diversification could mitigate the moral hazard problem. However for a single entrepreneur running many different projects might be increasingly costly due to overload costs. Delegating the running of projects to several managers can not only reduce overload costs, but also the moral hazard problem of external financing. In this paper we show that delegation can be the only way to exploit the gains from diversification when overload costs of diversification are high; delegation thus is the key ingredient to be able to diversify.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp403.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp403.

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Date of creation: Feb 2002
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Handle: RePEc:fmg:fmgdps:dp403

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  1. Robert H. Gertner & David S. Scharfstein & Jeremy C. Stein, 1994. "Internal versus External Capital Markets," NBER Working Papers 4776, National Bureau of Economic Research, Inc.
  2. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Boot, Arnoud W. A. & Schmeits, Anjolein, 2000. "Market Discipline and Incentive Problems in Conglomerate Firms with Applications to Banking," Journal of Financial Intermediation, Elsevier, vol. 9(3), pages 240-273, July.
  4. Jeremy C. Stein, 2001. "Agency, Information and Corporate Investment," NBER Working Papers 8342, National Bureau of Economic Research, Inc.
  5. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
  6. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  7. Shleifer, Andrei & Vishny, Robert W., 1989. "Management entrenchment : The case of manager-specific investments," Journal of Financial Economics, Elsevier, vol. 25(1), pages 123-139, November.
  8. Cerasi, Vittoria & Daltung, Sonja, 2000. "The optimal size of a bank: Costs and benefits of diversification," European Economic Review, Elsevier, vol. 44(9), pages 1701-1726, October.
  9. Qian, Yingyi, 1994. "Incentives and Loss of Control in an Optimal Hierarchy," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 527-44, July.
  10. Bengt Holmstrom & Jean Tirole, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," Working papers 95-1, Massachusetts Institute of Technology (MIT), Department of Economics.
  11. Li, David D & Li, Shan, 1996. " A Theory of Corporate Scope and Financial Structure," Journal of Finance, American Finance Association, vol. 51(2), pages 691-709, June.
  12. Berger, Philip G. & Ofek, Eli, 1995. "Diversification's effect on firm value," Journal of Financial Economics, Elsevier, vol. 37(1), pages 39-65, January.
  13. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
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Cited by:
  1. Carletti, Elena & Cerasi, Vittoria & Daltung, Sonja, 2007. "Multiple-bank lending: Diversification and free-riding in monitoring," Journal of Financial Intermediation, Elsevier, vol. 16(3), pages 425-451, July.
  2. Flaxio Toxvaerd, 2005. "Mergers, Diversification and Financial Intermediation," Money Macro and Finance (MMF) Research Group Conference 2005 43, Money Macro and Finance Research Group.
  3. Yoonhee Tina Chang, 2004. "Relationship Banking in Bilateral Oligopoly and Asymmetric Information," Econometric Society 2004 Far Eastern Meetings 734, Econometric Society.

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