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Strategic Cost of Diversification

Strategic Cost of Diversification This article proposes a new explanation for the large cross-sectional variation in the excess values of diversified firms. The model applies the idea of shareholders' limited liability affecting firms' output market strategies to the analysis of financial and operating choices of conglomerates. The inability of conglomerates to commit to unconstrained optimal operating strategies, following from the lack of flexibility in choosing their divisions' capital structures, reduces their value. Thus, the model highlights a new type of inefficiency of the conglomerate organizational structure, which is suboptimal financing. The predictions of the model are generally supported by the data. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Financial Studies Oxford University Press

Strategic Cost of Diversification

The Review of Financial Studies , Volume 20 (6) – Nov 28, 2007

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References (49)

Publisher
Oxford University Press
Copyright
Copyright © The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies.
Subject
Articles
ISSN
0893-9454
eISSN
1465-7368
DOI
10.1093/rfs/hhm047
Publisher site
See Article on Publisher Site

Abstract

This article proposes a new explanation for the large cross-sectional variation in the excess values of diversified firms. The model applies the idea of shareholders' limited liability affecting firms' output market strategies to the analysis of financial and operating choices of conglomerates. The inability of conglomerates to commit to unconstrained optimal operating strategies, following from the lack of flexibility in choosing their divisions' capital structures, reduces their value. Thus, the model highlights a new type of inefficiency of the conglomerate organizational structure, which is suboptimal financing. The predictions of the model are generally supported by the data.

Journal

The Review of Financial StudiesOxford University Press

Published: Nov 28, 2007

Keywords: JEL G32 G34 L13

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