What Do We Know About Cross-subsidization? Evidence from Merging Firms

Judith Chevalier

The B.E. Journal of Economic Analysis & Policy, 2004, vol. 4, issue 1, 1-29

Abstract: A substantial empirical literature documents value-destroying “cross-subsidization” among the divisions of diversified firms. However, this literature relies upon two maintained hypotheses: that divisions of diversified firms are randomly allocated to their corporate parents and that the investment opportunities facing conglomerate divisions are identical to those of stand-alone firms in their industries. I examine the investment behavior prior to merger of a sample of firms that undertook diversifying mergers between 1980 and 1995. I show that, in my sample, investment patterns that the literature has attributed to cross-subsidization between divisions are apparent in the pairs of merging firms prior to their mergers. Thus, some of the cross-subsidization results in the literature may be attributable to selection bias. I also examine stock market responses to announcements of diversifying acquisitions. The event responses are largely independent of measures of the extent to which the merger is diversifying.

Date: 2004
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Citations: View citations in EconPapers (52)

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DOI: 10.2202/1538-0637.1218

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