The Boundaries of the Firm: The Choice between Stand-Alone and Integrated Firms

51 Pages Posted: 11 Sep 2000

See all articles by Elazar Berkovitch

Elazar Berkovitch

Interdisciplinary Center, Herzliyah

Ronen Israel

Interdisciplinary Center, Herzliyah

Efrat Tolkowsky

Technion-Israel Institute of Technology - The William Davidson Faculty of Industrial Engineering & Management

Date Written: February 1999

Abstract

This study presents a theory of incorporation mode selection. It outlines when economic units should incorporate as stand-alone firms vs. an integrated firm (conglomerate). The theory suggests that an integrated firm better controls agency problems through manager competition for project acceptance. However, this incorporation mode reduces the ability to receive division-specific project information from the market. Based on this tradeoff, we show that divisions within a conglomerate have different characteristics than stand-alone firms. These differences explain why and when conglomerates will be traded at a "discount" or a "premium" compared to stand-alone firms. Furthermore, the theory explains differences in the required rate of return and productivity between stand-alone firms and conglomerates and how they relate to conglomerate premium and discount as well as stock price reaction to divestiture and merger announcements.

JEL Classification: G31, G34, D23

Suggested Citation

Berkovitch, Elazar and Israel, Ronen and Tolkowsky, Efrat, The Boundaries of the Firm: The Choice between Stand-Alone and Integrated Firms (February 1999). Available at SSRN: https://ssrn.com/abstract=238869 or http://dx.doi.org/10.2139/ssrn.238869

Elazar Berkovitch

Interdisciplinary Center, Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

Ronen Israel (Contact Author)

Interdisciplinary Center, Herzliyah ( email )

P.O. Box 167
Herzliya, 4610101
Israel
972-9-9527306 (Phone)

Efrat Tolkowsky

Technion-Israel Institute of Technology - The William Davidson Faculty of Industrial Engineering & Management ( email )

Haifa 32000
Israel

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