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The Boundaries of the Firm: The Choice Between Stand‐Alone and Integrated Firms

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  • Elazar Berkovitch
  • Ronen Israel
  • Efrat Tolkowsky

Abstract

This study presents a theory of corporate structure selection. It outlines when economic units should be structured as stand‐alone firms versus an integrated firm (conglomerate). The theory suggests that an integrated firm better controls agency problems through yardstick competition between managers for project acceptance. However, this structure reduces the ability to receive division‐specific project information from the market. Based on this trade‐off, we show that divisions within a conglomerate have different characteristics and, thus, different valuations than “similar” stand‐alone firms. Our theory also explains differences in the required rate of return between stand‐alone firms and conglomerates and how they relate to relative valuations of conglomerates and “similar” stand‐alone firm. It also predicts when stock price reaction to divestiture and merger announcements will be positive or negative.

Suggested Citation

  • Elazar Berkovitch & Ronen Israel & Efrat Tolkowsky, 2006. "The Boundaries of the Firm: The Choice Between Stand‐Alone and Integrated Firms," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 15(4), pages 821-851, December.
    • Handle: RePEc:bla:jemstr:v:15:y:2006:i:4:p:821-851
    DOI: 10.1111/j.1530-9134.2006.00119.x
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    References listed on IDEAS

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    Cited by:

    1. Akbel, Basak & Schnitzer, Monika, 2011. "Creditor rights and debt allocation within multinationals," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1367-1379, June.
    2. Renucci, Antoine, 2008. "Access to financing, rents, and organization of the firm," Journal of Corporate Finance, Elsevier, vol. 14(4), pages 337-346, September.
    3. Antoine Renucci, 2008. "Access to financing, rents, and organization of the firm," Post-Print halshs-00365983, HAL.

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