Investment Opportunities, Liquidity Premium, and Conglomerate Mergers
Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)
Indiana University - Kelley School of Business - Department of Finance; China Academy of Financial Research (CAFR)
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.
Number of Pages in PDF File: 42
Keywords: mergers and spinoffs, corporate diversification and focus, security design, allocative information, liquidity
JEL Classification: D82, G34, L22
Date posted: July 2, 1999 ; Last revised: May 14, 2014