Value of Conglomerates and Capital Market Conditions

Abstract

This paper studies the variation in the value of diversification across time under various capital market conditions. We find that the value of conglomerates increases relative to focused firms when external capital is more costly at the aggregate level. We also find that such an increase is more profound for financially-constrained conglomerates, such as bank-dependent conglomerates or small conglomerates. Thus, our results support the existing theoretical literature on the advantage of diversification over focus, i.e., the ability of conglomerates to substitute costly external capital markets with internal capital markets. In particular, our findings suggest that the availability of internal capital market creates value when the financing cost in external capital markets is high, especially for those financially-constrained conglomerates.

Keywords: Diversification, Internal Capital Market, Financial Constraint,

JEL Classification: G32, G34