Discounted But Not Diversified: Organizational Structure and Conglomerate Discount
67 Pages Posted: 14 Aug 2006
Date Written: July 28, 2006
I document a large and significant diversification discount in multi-division firms that are diversified neither industrially nor geographically. All divisions of these firms, which are called "pseudo-conglomerates", operate in the same finely defined industry. Since divisions of pseudo-conglomerates face similar investment opportunities, the resource allocation problem is less severe and, perhaps, non-existent in these firms. This implies that inefficient internal capital market and diversity across industries play a smaller role in the well-documented conglomerate discount. I also analyze an exogenous event - change in segment-reporting rules from SFAS 14 to SFAS 131 in 1997. I find that standalone firms start trading at a discount when they begin reporting multiple segments after the rule change. This suggests that revealing a more complex organizational structure results in value loss. Together, these results suggest that the diversification discount may be more appropriately called an "organizational" discount.
Keywords: Diversification discount, SFAS 131, internal capital markets, conglomerate
JEL Classification: G12, G31, L22, M41, M44, M45
Suggested Citation: Suggested Citation