Short Sales Constraints and the Diversification Puzzle
68 Pages Posted: 28 Jul 2015 Last revised: 29 Apr 2016
Date Written: April 29, 2016
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: Suggested Citation