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Corporate Diversification and the Cost of Capital

88 Pages Posted: 21 Mar 2009 Last revised: 25 Oct 2012

Rebecca N. Hann

University of Maryland - Robert H. Smith School of Business

Maria Ogneva

University of Southern California - Marshall School of Business

Oguzhan Ozbas

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Date Written: October 24, 2012

Abstract

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.

Keywords: Corporate diversification, Coinsurance, Cost of capital

Suggested Citation

Hann, Rebecca N. and Ogneva, Maria and Ozbas, Oguzhan, Corporate Diversification and the Cost of Capital (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. Available at SSRN: https://ssrn.com/abstract=1364481 or http://dx.doi.org/10.2139/ssrn.1364481

Rebecca N. Hann

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

Maria Ogneva

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA 90089
United States

Oguzhan Ozbas (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-0781 (Phone)
213-740-6650 (Fax)

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