Valuation-driven profit transfer among corporate segments

Haifeng You ()
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Haifeng You: Hong Kong University of Science and Technology

Review of Accounting Studies, 2014, vol. 19, issue 2, No 9, 805-838

Abstract: Abstract This paper investigates whether the desire to achieve higher equity valuations induces conglomerates to manipulate their segment earnings. I extend the Stein (Q J Econ 104:655–669, 1989) model to a multi-segment setting and show that conglomerates have incentives to transfer profits from segments operating in industries with lower valuation multiples to those with higher multiples, even if the market is not fooled in equilibrium. If companies engage in such manipulation, segments with relatively high (low) valuations should report abnormally high (low) profits. The empirical tests confirm this prediction and further show that the relation is stronger for firms with more dispersed segment valuations. This paper also demonstrates that the simple sum-of-the-parts valuation with multiples tends to overestimate the enterprise values for conglomerates and that the measurement errors increase with segment valuation dispersion.

Keywords: Earnings management; Segment reporting; Market efficiency; Diversification discount (search for similar items in EconPapers)
JEL-codes: G34 M40 M41 (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1007/s11142-013-9264-5

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