Uncertainty About Average Profitability and the Diversification Discount

Posted: 27 Mar 2008 Last revised: 19 Oct 2010

John Hund

University of Georgia

Donald Monk

Rutgers Business School

Sheri Tice

Tulane University - A.B. Freeman School of Business

Date Written: February 11, 2010

Abstract

The diversification discount (multiple segment firm value below the value imputed using single segment firm multiples) is commonly thought to be generated by agency problems, a lack of transparency, or lackluster future prospects for diversified firms. If multiple segment firms have lower uncertainty about mean profitability than single segment firms, rational learning about mean profitability provides an alternative explanation for the diversification discount that does not rely on suboptimal managerial decisions or a poor firm outlook. Empirical tests which examine changes in firm value across the business cycle and idiosyncratic volatility are consistent with lower uncertainty about mean profitability for multiple segment firms.

Keywords: Diversification discount, Rational learning models, Internal capital markets

JEL Classification: G10, G30, G32

Suggested Citation

Hund, John and Monk, Donald and Tice, Sheri, Uncertainty About Average Profitability and the Diversification Discount (February 11, 2010). Journal of Financial Economics (JFE), Vol. 96, pp. 463-484, 2010; AFA 2009 San Francisco Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1107592

John Hund

University of Georgia ( email )

Athens, GA 30602
United States

Donald Monk

Rutgers Business School ( email )

100 Rockafeller Road
Piscataway, NJ 08854-8054
United States

HOME PAGE: http://www.business.rutgers.edu/faculty-research/directory/monk-donald

Sheri Tice (Contact Author)

Tulane University - A.B. Freeman School of Business ( email )

A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States
504-865-5469 (Phone)
504-865-6751 (Fax)

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