Conglomerate Investment, Skewness, and the CEO Long Shot Bias

Abstract

We show that segment-level capital expenditure in conglomerates is increasing in the expected skewness of segment returns. Conglomerates with a high-skewness segment are valued at a substantial discount of up to 15%, which indicates overinvestment that is detrimental to shareholder wealth. Conglomerates invest significantly more in these segments than matched stand-alones. The findings are robust to industry, firm, and segment fixed effects, and are not driven by simple valuation mistakes, investment opportunities, or agency problems. Using a proxy based on geographical variation in gambling norms, we show that the skewness-investment relation is particularly pronounced when CEOs are likely to find gambling attractive. The results are the first evidence to show that skewness is related to capital budgeting and the first to suggest that biased CEOs who try to pick winners are betting on long shots, instead.

Keywords: behavioral finance, skewness, investment

JEL Classification: G11, G31, G34