The Impact of Corporate Diversification on the Option Value of Equity

53 Pages Posted: 18 Mar 2009

Date Written: March 18, 2009

Abstract

This article quantifies the effect of risk-reducing corporate diversification on the option value of equity using contingent claims analysis. The impact of conglomeration on firm risk is heavily conditioned on firm size. In contrast to small firms, the risk of large firms does not decline with increasing conglomeration. Accounting for this effect, the expected equity discount is much lower than commonly assumed and can even turn into a premium if the path dependency of equity is incorporated. These results stand in direct contrast to those of Mansi and Reeb (2002) and caution against using asset substitution as a qualitative argument for explaining broad economic phenomena involving shareholder value.

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

JEL Classification: G13, G31

Suggested Citation

Grass, Gunnar, The Impact of Corporate Diversification on the Option Value of Equity (March 18, 2009). Available at SSRN: https://ssrn.com/abstract=1362523 or http://dx.doi.org/10.2139/ssrn.1362523

Gunnar Grass (Contact Author)

HEC Montréal ( email )

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

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