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Conglomerate Entrenchment under Optimal Financial Contracting

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  • Roman Inderst

Abstract

We provide a formal analysis of the notion that conglomerates are more ‘entrenched’ as they have ‘deeper pockets’. Using the financial contracting model of Bolton and Scharfstein (1990), we can isolate two effects that confirm this conjecture: the pooling of cash flows, which allows to smooth out repayments, and the ability to obtain better credit terms. For less profitable business segments, the internal capital market operated in a conglomerate may, however, work in the opposite direction, increasing the sensitivity of operations to own cash flows and increasing the likelihood of exit.

Suggested Citation

  • Roman Inderst, 2004. "Conglomerate Entrenchment under Optimal Financial Contracting," FMG Discussion Papers dp521, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp521
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    References listed on IDEAS

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    3. Iskenderoglu, Cansu, 2023. "Product market competition and the value of diversification," Finance Research Letters, Elsevier, vol. 58(PA).
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    5. Gatzer, Sebastian & Hoang, Daniel & Ruckes, Martin, 2014. "Internal capital markets and diversified firms: Theory and practice," Working Paper Series in Economics 64, Karlsruhe Institute of Technology (KIT), Department of Economics and Management.
    6. Peter J. Simmons & Anna Maria C. Menichini, 2022. "Efficient audits by pooling independent projects: Separation vs. conglomeration," Discussion Papers 22/06, Department of Economics, University of York.
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    8. Viswanathan Nagarajan & Pitabas Mohanty & Apalak Khatua, 2023. "Financing effects of corporate diversification: A review," Review of Managerial Science, Springer, vol. 17(7), pages 2555-2585, October.
    9. Marc Martos-Vila & Matthew Rhodes-Kropf & Jarrad Harford, 2013. "Financial vs. Strategic Buyers," NBER Working Papers 19378, National Bureau of Economic Research, Inc.
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    More about this item

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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