THE CONGLOMERATE DISCOUNT: A NEW EXPLANATION BASED ON CREDIT RISK

Manuel Ammann () and Michael Verhofen ()
Additional contact information
Manuel Ammann: Swiss Institute of Banking and Finance, University of St. Gallen, Rosenbergstrasse 52, CH-9000, St. Gallen, Switzerland
Michael Verhofen: Swiss Institute of Banking and Finance, University of St. Gallen, Rosenbergstrasse 52, CH-9000, St. Gallen, Switzerland

International Journal of Theoretical and Applied Finance (IJTAF), 2006, vol. 09, issue 08, 1201-1214

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.

Keywords: Conglomerate; diversification; discount; credit risk; limited liability (search for similar items in EconPapers)
Date: 2006
References: View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
http://www.worldscientific.com/doi/abs/10.1142/S0219024906004025
Access to full text is restricted to subscribers

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:ijtafx:v:09:y:2006:i:08:n:s0219024906004025

Ordering information: This journal article can be ordered from

DOI: 10.1142/S0219024906004025

Access Statistics for this article

International Journal of Theoretical and Applied Finance (IJTAF) is currently edited by L P Hughston

More articles in International Journal of Theoretical and Applied Finance (IJTAF) from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().