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The impact of conglomeration on the option value of equity

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  • Grass, Gunnar

Abstract

Using contingent claims analysis, I quantify the effect of risk-reducing corporate diversification on the value of equity as a call option on firm assets. The impact of conglomeration on firm risk is heavily conditioned on firm size. In contrast to small firms, the risk of large firms does not decline with increasing conglomeration. Accounting for this effect, the expected equity discount is much lower than commonly assumed and can even turn into a premium if the path dependency of equity is incorporated. My results stand in direct contrast to those of Mansi and Reeb (2002) and caution against using asset substitution as a qualitative argument for explaining economy-wide value phenomena.

Suggested Citation

  • Grass, Gunnar, 2010. "The impact of conglomeration on the option value of equity," Journal of Banking & Finance, Elsevier, vol. 34(12), pages 3010-3024, December.
    • Handle: RePEc:eee:jbfina:v:34:y:2010:i:12:p:3010-3024
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    2. Chao, Ching-Hsiang & Huang, Chih-Jen & Ho, Ruey-Jenn & Huang, Hsin-Yi, 2022. "Catering to investors through capital expenditures: Testing assets substitution problem around financing," The North American Journal of Economics and Finance, Elsevier, vol. 59(C).
    3. Christian Dorion & Pascal François & Gunnar Grass & Alexandre Jeanneret, 2014. "Convertible Debt and Shareholder Incentives," Cahiers de recherche 1403, CIRPEE.
    4. Stefan Erdorf & Thomas Hartmann-Wendels & Nicolas Heinrichs & Michael Matz, 2012. "Corporate Diversification and Firm Value: A Survey of Recent Literature," Cologne Graduate School Working Paper Series 03-01, Cologne Graduate School in Management, Economics and Social Sciences.
    5. Dorion, Christian & François, Pascal & Grass, Gunnar & Jeanneret, Alexandre, 2014. "Convertible debt and shareholder incentives," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 38-56.
    6. Stefan Erdorf & Thomas Hartmann-Wendels & Nicolas Heinrichs & Michael Matz, 2013. "Corporate diversification and firm value: a survey of recent literature," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 27(2), pages 187-215, June.
    7. Schmid, Markus M. & Walter, Ingo, 2012. "Geographic diversification and firm value in the financial services industry," Journal of Empirical Finance, Elsevier, vol. 19(1), pages 109-122.

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