Strategic Cost of Diversification
Posted: 26 Jun 2008 Last revised: 19 Apr 2018
This paper proposes a new explanation for the large cross-sectional variation in the excess values of diversiﬁed ﬁrms. The model applies the idea of shareholders’ limited liability affecting ﬁrms’ output market strategies to the analysis of ﬁnancial and operating choices of conglomerates. The inability of conglomerates to commit to unconstrained optimal operating strategies, following from the lack of ﬂexibility in choosing their divisions’ capital structures, reduces their value. Thus, the model highlights a new type of inefficiency of the conglomerate organizational structure, which is suboptimal ﬁnancing. The predictions of the model are generally supported by the data.
Keywords: diversiﬁed ﬁrms, excess values, conglomerate mergers, competitive interaction, capital structure
JEL Classification: G32, G34, L13
Suggested Citation: Suggested Citation