The Impact of the Corporate Diversification on the Option Value of Equity

Abstract

The article investigates the effect of risk-reducing corporate diversification on the option value of equity. The impact of conglomeration on firm risk is heavily conditioned on firm size. In contrast to small firms, the risk of big firms does not reduce with increasing conglomeration. Accounting for this effect, the expected equity discount is much lower than commonly assumed and - incorporating equity's path dependency - can even turn into a premium. Results stand in direct contrast to those of Mansi and Reeb (2002) and caution against using asset substitution as a qualitative argument for explaining economy-wide value phenomena.

Keywords: Contingent-claims analysis, Corporate Diversification, Risk-Shifting

JEL Classification: G13, G31