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

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  • Chevalier Judith

    () (Yale University)

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.

Suggested Citation

  • Chevalier Judith, 2004. "What Do We Know About Cross-subsidization? Evidence from Merging Firms," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 4(1), pages 1-29, April.
  • Handle: RePEc:bpj:bejeap:v:advances.4:y:2004:i:1:n:3
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    Cited by:

    1. Seru, Amit, 2014. "Firm boundaries matter: Evidence from conglomerates and R&D activity," Journal of Financial Economics, Elsevier, vol. 111(2), pages 381-405.
    2. Chira, Inga & Volkov, Nikanor, 2017. "The choice of sale method and its consequences in mergers and acquisitions," The Quarterly Review of Economics and Finance, Elsevier, vol. 63(C), pages 170-184.
    3. Chen, Sheng-Syan & Chen, I-Ju, 2012. "Corporate governance and capital allocations of diversified firms," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 395-409.
    4. GAUTIER, Axel & HAMADI, Malika, 2004. "Internal capital market efficiency of Belgian holding companies," CORE Discussion Papers 2004086, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    5. 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, vol. 51(2), pages 162-172, May.
    6. Bakke, Tor-Erik & Gu, Tiantian, 2017. "Diversification and cash dynamics," Journal of Financial Economics, Elsevier, vol. 123(3), pages 580-601.
    7. Choe, Chongwoo & Yin, Xiangkang, 2009. "Diversification discount, information rents, and internal capital markets," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(2), pages 178-196, May.
    8. Glaser, Markus & Müller, Sebastian, 2006. "Der Diversification Discount in Deutschland: Existiert ein Bewertungsabschlag für diversifizierte Unternehmen?," Sonderforschungsbereich 504 Publications 06-13, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
    9. Yan, An & Yang, Zaihui & Jiao, Jie, 2010. "Conglomerate investment under various capital market conditions," Journal of Banking & Finance, Elsevier, vol. 34(1), pages 103-115, January.
    10. 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.
    11. David, Guy & Lindrooth, Richard C. & Helmchen, Lorens A. & Burns, Lawton R., 2014. "Do hospitals cross-subsidize?," Journal of Health Economics, Elsevier, vol. 37(C), pages 198-218.
    12. Glaser, Markus & Müller, Sebastian, 2010. "Is the diversification discount caused by the book value bias of debt?," Journal of Banking & Finance, Elsevier, vol. 34(10), pages 2307-2317, October.
    13. Hornstein, Abigail S. & Nguyen, Zachary, 2014. "Is more less? Propensity to diversify via M&A and market reactions," International Review of Financial Analysis, Elsevier, vol. 34(C), pages 76-88.
    14. Wulf, Julie, 2009. "Influence and inefficiency in the internal capital market," Journal of Economic Behavior & Organization, Elsevier, vol. 72(1), pages 305-321, October.
    15. 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, vol. 10(1), pages 1-22, March.
    16. Yan-Jie Yang & Jungpao Kang & Ruey-Ching Lin & Joshua Ronen, 2016. "Auditor selection within a business group: evidence from Taiwan," Review of Quantitative Finance and Accounting, Springer, vol. 46(2), pages 195-215, February.
    17. Ekkayokkaya, Manapol & Paudyal, Krishna, 2015. "A trade-off in corporate diversification," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 275-292.
    18. 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;Swiss Society for Financial Market Research, vol. 27(2), pages 187-215, June.
    19. Glaser, Markus & Müller, Sebastian, 2006. "Der Diversification Discount in Deutschland : existiert ein Bewertungsabschlag für diversifizierte Unternehmen?," Papers 06-13, Sonderforschungsbreich 504.

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