Essays in corporate finance

Sanzhar, Sergey (2005) Essays in corporate finance. Doctoral thesis, University of London: London Business School.

Abstract

The thesis consists of two parts containing three empirical studies in corporate finance. Part I examines the diversification discount, and part II analyzes the debt overhang problem. Chapter 2 examines the well-documented problem of "diversification discount", a phenomenon when businesses have lower value inside a conglomerate than as separate firms. I document a large and significant diversification discount in multi-division firms that are diversified neither industrially nor geographically. All divisions of these firms, which are called "pseudo-conglomerates", operate in the same finely defined industry. Since divisions of pseudo-conglomerates face similar investment opportunities, the resource allocation problem is less severe and, perhaps, non-existent in these firms. Thus, inefficient internal capital market and industrial diversification play a smaller role in the well-documented conglomerate discount. Chapter 3 of part I examines an event - change in segment-reporting rules from SFAS 14 to SFAS 131 in 1997, which allows assessing the value impact of corporate diversification, while minimizing the endogeneity problem of diversification decision in prior studies. I find that standalone firms start trading at a discount when they begin reporting multiple segments after the rule change. This suggests that revealing a more complex organizational structure results in value loss. Together with Chapter 1, my results point to the importance of organizational structure rather than industrial or geographical composition for explaining the effect of diversification on firm value. The second part is titled -Evidence on debt overhang from distressed equity issues". This chapter is the first study of equity issues as a mean of resolving financial distress. Shareholders have strong disincentives to contribute new funds if by doing so they significantly improve the value of existing debt. Despite the theoretical importance very little is known about debt overhang empirically. Overall, our results suggest that debt overhang for even highly leveraged and distressed firms does not impede raising new equity, does not appear to be affecting the survival of distressed firms, and therefore debt overhang is unlikely to be very significant in practice.