The Impact of the Corporate Diversification on the Option Value of Equity

46 Pages Posted: 25 Mar 2008 Last revised: 15 Feb 2009

Date Written: February 4, 2009

Abstract

The article investigates the effect of risk-reducing corporate diversification on the option value of equity. The impact of conglomeration on firm risk is heavily conditioned on firm size. In contrast to small firms, the risk of big firms does not reduce with increasing conglomeration. Accounting for this effect, the expected equity discount is much lower than commonly assumed and - incorporating equity's path dependency - can even turn into a premium. Results stand in direct contrast to those of Mansi and Reeb (2002) and caution against using asset substitution as a qualitative argument for explaining economy-wide value phenomena.

Keywords: Contingent-claims analysis, Corporate Diversification, Risk-Shifting

JEL Classification: G13, G31

Suggested Citation

Grass, Gunnar, The Impact of the Corporate Diversification on the Option Value of Equity (February 4, 2009). Available at SSRN: https://ssrn.com/abstract=1107247 or http://dx.doi.org/10.2139/ssrn.1107247

Gunnar Grass (Contact Author)

HEC Montréal ( email )

3000, Chemin de la Côte-Sainte-Catherine
Montreal, Quebec H3T2A7
Canada
5143401540 (Phone)

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