Market Discipline and Incentive Problems in Conglomerate Firms with Applications to Banking

Posted: 28 Jul 2000

See all articles by Arnoud W. A. Boot

Arnoud W. A. Boot

University of Amsterdam - Amsterdam Business School; Centre for Economic Policy Research (CEPR); Tinbergen Institute

Anjolein Schmeits

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance

Abstract

This paper analyzes the optimality of conglomeration. We show thatthe potential benefits of conglomeration depend critically on the effectiveness of market discipline for stand-alone activities. Effective market discipline reduces the benefits of conglomeration. With ineffective market discipline of stand-alone activities, conglomeration would further undermine market discipline, but may nevertheless be beneficial. In particular, when rents are not too high, the diversification benefits of conglomeration dominate the negative incentive effects. A more competitive environment therefore induces conglomeration. We also show that introducing internal cost-of-capital allocation schemes creates internal market discipline that complements the weak external market discipline of a conglomeration. Our analysis sheds light on the Barings debacle and other recent developments in the banking sector.

JEL Classification: G21, G28

Suggested Citation

Boot, Arnoud W. A. and Schmeits, Anjolein B., Market Discipline and Incentive Problems in Conglomerate Firms with Applications to Banking. Available at SSRN: https://ssrn.com/abstract=228768

Arnoud W. A. Boot (Contact Author)

University of Amsterdam - Amsterdam Business School ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands
+31 20 525 4162 (Phone)
+31 20 525 5318 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Anjolein B. Schmeits

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

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