Corporate Diversification and the Cost of Capital
Rebecca N. Hann
University of Maryland
University of Southern California - Marshall School of Business
University of Southern California - Marshall School of Business - Finance and Business Economics Department
October 24, 2012
Journal of Finance, Forthcoming
Marshall School of Business Working Paper No. FBE 32-09
Rock Center for Corporate Governance at Stanford University Working Paper No. 58
AFA 2011 Denver Meetings Paper
We examine whether organizational form matters for a firm's cost of capital. Contrary to conventional view, we argue that coinsurance among a firm's business units can reduce systematic risk through the avoidance of countercyclical deadweight costs. We find that diversified firms have on average a lower cost of capital than comparable portfolios of standalone firms. In addition, diversified firms with less correlated segment cash flows have a lower cost of capital, consistent with a coinsurance effect. Holding cash flows constant, our estimates imply an average value gain of approximately 5% when moving from the highest to the lowest cash flow correlation quintile.
Number of Pages in PDF File: 88
Keywords: Corporate diversification, Coinsurance, Cost of capital
Date posted: March 21, 2009 ; Last revised: October 25, 2012
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