| Abstract: | This article proposes a new explanation for the large cross-sectionalvariation in the excess values of diversified firms. The modelapplies the idea of shareholders' limited liability affectingfirms' output market strategies to the analysis of financialand operating choices of conglomerates. The inability of conglomeratesto commit to unconstrained optimal operating strategies, followingfrom the lack of flexibility in choosing their divisions' capitalstructures, reduces their value. Thus, the model highlightsa new type of inefficiency of the conglomerate organizationalstructure, which is suboptimal financing. The predictions ofthe model are generally supported by the data. |
