Investment Opportunities, Liquidity Premium, and Conglomerate Mergers

42 Pages Posted: 2 Jul 1999 Last revised: 14 May 2014

Chun Chang

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Xiaoyun Yu

Indiana University - Kelley School of Business - Department of Finance; China Academy of Financial Research (CAFR)

Multiple version iconThere are 2 versions of this paper

Date Written: January 2004

Abstract

In this article we show that in a finitely liquid market with asymmetrically informed investors, both the benefits and the costs of diversification vary with the return and risk of the investment opportunities of the firm's divisions. The benefits come from a reduced liquidity discount in the stock price of the merged firm when its shareholders anticipate less informed trading. The costs are the result of less efficient investment by the merged firm's divisions due to a less informative stock price. Our results provide explanations for the life cycle of diversification strategies and implications for evaluating merger and spin-off candidates.

Keywords: mergers and spinoffs, corporate diversification and focus, security design, allocative information, liquidity

JEL Classification: D82, G34, L22

Suggested Citation

Chang, Chun and Yu, Xiaoyun, Investment Opportunities, Liquidity Premium, and Conglomerate Mergers (January 2004). Available at SSRN: https://ssrn.com/abstract=167630 or http://dx.doi.org/10.2139/ssrn.167630

Chun Chang (Contact Author)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Xiaoyun Yu

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3521 (Phone)
812-855-5875 (Fax)

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

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