Mountain or molehill? Downward biases in the conglomerate discount measure

Christin Rudolph and Bernhard Schwetzler

Journal of Banking & Finance, 2014, vol. 40, issue C, 420-431

Abstract: The Berger and Ofek (1995) excess value measure, comparing a conglomerate’s actual market value to an imputed value based on standalones, has become the standard method to determine value effects of diversification. In this paper, we address a significant bias in this procedure stemming from the difference in cash holdings between diversified and standalone firms. Excess values are based on firm values, including corporate cash positions. As standalones hold significantly more cash, the imputed cash value is higher than the conglomerate’s actual cash value, resulting in a downward biased excess value. We thus propose to calculate excess values based on enterprise values, replacing total debt by net debt. Based on an extensive US sample, we show that there is significantly less evidence of a diversification discount when adjusting for the cash bias. In terms of average dollar losses, the firm value-based models overestimate the conglomerate discount by at least 25%. Apart from removing the cash bias, we propose a second modification to the excess value measure, arguing that standalone industry multipliers should be calculated using geometric mean aggregation instead of median aggregation.

Keywords: Conglomerate discount; Cash bias; Multiplier aggregation bias (search for similar items in EconPapers)
JEL-codes: G31 G32 G34 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:40:y:2014:i:c:p:420-431

DOI: 10.1016/j.jbankfin.2013.12.007

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