Two Puzzles about the Diversification Discount: SFAS # 131 and "Pseudo-Conglomerates"

Finance

IFA Working Paper

2003

I document a large and significant diversification discount in multi-division firms that are diversified neither industrially or geographically. All divisions of these firms, which are called "pseudo-conglomerates", operate in the same finely defined industry. Since divisions of pseudo-conglomerates should face similar investment opportunities, this suggests that the well-documented conglomerate discount is not caused by inefficient internal capital markets. Using pseudo-conglomerates avoids the measurement error problem that contaminated previous evidence on conglomerate capital misallocation. I also analyse 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 larger amount of diversification results in a value loss.

Institute of Finance and Accounting

FIN 378

IFA Working Paper

No