The Conglomerate Discount: A New Explanation Based on Credit Risk
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CONTRIBUTORS:
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JOURNAL:
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YEAR:
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2006
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PUB TYPE:
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Journal Article
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SUBJECT(S):
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Conglomerate; diversification; discount; credit risk; limited liability
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DISCIPLINE:
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Economics
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HTTP:
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http://www.manuel-ammann.com
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LANGUAGE:
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English
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PUB ID:
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103-436-730
(Last edited on
2007/07/30 09:12:19 GMT-6)
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SPONSOR(S):
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ABSTRACT:
We present a simple new explanation for the diversification discount in the valuation of firms. We demonstrate that, ceteris paribus, limited liability of equity holders is sufficient to explain a diversification discount. To derive this result, we use a credit risk model based on the value of the firm's assets. We show that a conglomerate can be regarded as an option on a portfolio of assets. By splitting up the conglomerate, the investor receives a portfolio of options on assets. The conglomerate discount arises because the value of a portfolio of options is always equal to or higher than the value of an option on a portfolio. The magnitude of the conglomerate discount depends on the number of business units and their correlation, as well as their volatility, among other factors.
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STATISTICS
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