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Short Sales Constraints and the Diversification Puzzle

68 Pages Posted: 28 Jul 2015 Last revised: 29 Apr 2016

Adam V. Reed

University of North Carolina Kenan-Flagler Business School

Pedro A. C. Saffi

University of Cambridge - Judge Business School

Edward Dickersin Van Wesep

University of Colorado at Boulder - Department of Finance

Date Written: April 29, 2016

Abstract

Building on Miller's (1977) short sales constraints insight, we construct a model showing that investors should disagree less about the valuation of a conglomerate than about the valuations of its individual divisions. Disagreement, combined with short sales constraints, increases asset prices and thereby implies a conglomerate discount. The model provides a wide variety of empirically testable implications about the incidence and size of the conglomerate discount. We test several of these predictions, and find that (i) conglomerates face fewer short sales constraints and have less dispersion of opinion than focused firms, and (ii) the conglomerate discount increases with short sales constraints and decreases with differences of opinion. While we are unable to fully explain the conglomerate discount through proxies of short sales constraints and differences of opinion, we find that they reduce its magnitude by between 50-70% using matched sample estimates.

Keywords: Conglomerate discount, short sales constraints, equity lending, differences of opinion

JEL Classification: G10, G11, G14, G18, G28, G32

Suggested Citation

Reed, Adam V. and Saffi, Pedro A. C. and Van Wesep, Edward Dickersin, Short Sales Constraints and the Diversification Puzzle (April 29, 2016). Available at SSRN: https://ssrn.com/abstract=2636770 or http://dx.doi.org/10.2139/ssrn.2636770

Adam V. Reed

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Pedro A. C. Saffi (Contact Author)

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom

HOME PAGE: http://www.pedrosaffi.com

Edward Dickersin Van Wesep

University of Colorado at Boulder - Department of Finance ( email )

Campus Box 419
Boulder, CO 80309
United States

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