The Boundaries of the Firm: The Choice between Stand-Alone and Integrated Firms
51 Pages Posted: 11 Sep 2000
Date Written: February 1999
Abstract
This study presents a theory of incorporation mode selection. It outlines when economic units should incorporate as stand-alone firms vs. an integrated firm (conglomerate). The theory suggests that an integrated firm better controls agency problems through manager competition for project acceptance. However, this incorporation mode reduces the ability to receive division-specific project information from the market. Based on this tradeoff, we show that divisions within a conglomerate have different characteristics than stand-alone firms. These differences explain why and when conglomerates will be traded at a "discount" or a "premium" compared to stand-alone firms. Furthermore, the theory explains differences in the required rate of return and productivity between stand-alone firms and conglomerates and how they relate to conglomerate premium and discount as well as stock price reaction to divestiture and merger announcements.
JEL Classification: G31, G34, D23
Suggested Citation: Suggested Citation
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