Two Puzzles about the Diversification Discount: SFAS # 131 and "Pseudo-Conglomerates"

Sanzhar, S V (2003) Two Puzzles about the Diversification Discount: SFAS # 131 and "Pseudo-Conglomerates". Working Paper. London Business School IFA Working Paper.

Abstract

I document a large and significant diversification discount in multidivision firms that are diversified neither industrially or geographically. All divisions of these firms, which are called "pseudoconglomerates", operate in the same finely defined industry. Since divisions of pseudoconglomerates should face similar investment opportunities, this suggests that the welldocumented conglomerate discount is not caused by inefficient internal capital markets. Using pseudoconglomerates avoids the measurement error problem that contaminated previous evidence on conglomerate capital misallocation. I also analyse an exogenous event change in segmentreporting rules from SFAS 14 to SFAS 131 in 1997. 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 larger amount of diversification results in a value loss.