Is the Diversification Discount Caused by the Book Value Bias of Debt?

Journal of Banking and Finance, Forthcoming

40 Pages Posted: 20 Feb 2010

See all articles by Markus Glaser

Markus Glaser

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management)

Sebastian Müller

Technische Universität München (TUM) - TUM School of Management

Date Written: February, 19 2010

Abstract

We analyze whether the diversification discount is driven by the book value bias of corporate debt. Book values of debt may be a more downward biased proxy of the market value of debt for diversified firms, relative to undiversified firms, as diversification leads to lower firm risk. Thus, measures of firm value based on book values of debt undervalue diversified firms relative to focused firms. Our paper complements recent literature which uses market values to test the risk reduction hypothesis for a subsample of firms for which debt is traded. Alternatively, we employ market value of debt estimates for the whole firm universe. Consistent with the above hypothesis, we show that the use of book values of debt underestimates the value of diversified firms. There is no discount for mainly equity financed firms and lower distress risk and equity volatility for diversified firms. More concentrated ownership increases firm valuation.

Keywords: Diversification, Diversification discount, Conglomerate discount, Internal capital markets, Option pricing, Debt valuation, Merton model, Corporate governance, Ownership structure

JEL Classification: G12, G13, G14, G31

Suggested Citation

Glaser, Markus and Müller, Sebastian, Is the Diversification Discount Caused by the Book Value Bias of Debt? (February, 19 2010). Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1555653 or http://dx.doi.org/10.2139/ssrn.1555653

Markus Glaser (Contact Author)

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management) ( email )

Schackstraße 4
Munich, 80539
Germany

Sebastian Müller

Technische Universität München (TUM) - TUM School of Management ( email )

Germany

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