Diversification Discount, Information Rents, and Internal Capital Markets

38 Pages Posted: 16 Jan 2006

See all articles by Chongwoo Choe

Chongwoo Choe

Monash University - Department of Economics

Xiangkang Yin

Deakin University; Financial Research Network (FIRN)

Date Written: November 16, 2005

Abstract

While many existing studies report that corporate diversification destroys shareholder value, two recent studies challenge these findings. Schoar (2002) finds that plants in conglomerates are more productive than those in comparable single-segment firms, although conglomerates are traded at discounts. Villalonga (2004) employs a more comprehensive database than that used in the existing studies, and shows that there is a significant diversification premium, rather than discount. This paper develops a model that highlights the costs and benefits of corporate diversification. The diversified firm trades off the benefits of more efficient resource allocation through its internal capital market against the costs of information rents to division managers, which are necessary for effective workings of the internal capital market. We provide an argument supporting Schoar's findings, and identify conditions under which there can be a diversification discount or a premium.

Keywords: Diversification discount, information rents, internal capital market, multidivisional firm, single-segment firm

JEL Classification: G30, J30

Suggested Citation

Choe, Chongwoo and Yin, Xiangkang, Diversification Discount, Information Rents, and Internal Capital Markets (November 16, 2005). Available at SSRN: https://ssrn.com/abstract=875574 or http://dx.doi.org/10.2139/ssrn.875574

Chongwoo Choe (Contact Author)

Monash University - Department of Economics ( email )

Department of Economics
PO Box 197
Caulfield East, Victoria 3145
Australia
+61 2 9903 1125 (Phone)
+61 2 9903 1128 (Fax)

Xiangkang Yin

Deakin University ( email )

Melbourne, Victoria
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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