Valuation-Driven Profit Transfer Among Corporate Segments

51 Pages Posted: 11 Mar 2013 Last revised: 20 May 2013

See all articles by Haifeng You

Haifeng You

Hong Kong University of Science & Technology (HKUST) - Department of Accounting

Date Written: March 11, 2013

Abstract

This paper investigates whether the desire to achieve higher equity valuations induces conglomerates to manipulate their segment earnings. I extend the Stein (1989) model to a multi-segment setting and show that conglomerates have incentives to transfer profits from segments operating in industries with lower valuation multiples to those with higher multiples, even if the market is not fooled in equilibrium. If companies engage in such manipulation, segments with relatively high (low) valuations should report abnormally high (low) profits. The empirical tests confirm this prediction and further show that the relation is stronger for firms with more dispersed segment valuations. Finally, this paper also demonstrates that the simple sum-of-the-parts valuation with multiples tends to overestimate the enterprise values for conglomerates, and the measurement errors increase with segment valuation dispersions.

Keywords: Earnings management, segment reporting, market efficiency, diversification discount

JEL Classification: M40, M41, G34

Suggested Citation

You, Haifeng, Valuation-Driven Profit Transfer Among Corporate Segments (March 11, 2013). Review of Accounting Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2231336 or http://dx.doi.org/10.2139/ssrn.2231336

Haifeng You (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Accounting ( email )

Clear Water Bay
Kowloon
Hong Kong

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