Corporate Diversification and the Cost of Capital

  • Author(s): REBECCA N. HANN, MARIA OGNEVA, OGUZHAN OZBAS
  • Published: Sep 10, 2013
  • Pages: 1961-1999
  • DOI: 10.1111/jofi.12067

ABSTRACT

We examine whether organizational form matters for a firm's cost of capital. Contrary to the conventional view, we argue that coinsurance among a firm's business units can reduce systematic risk through the avoidance of countercyclical deadweight costs. We find that diversified firms have, on average, a lower cost of capital than comparable portfolios of stand‐alone firms. In addition, diversified firms with less correlated segment cash flows have a lower cost of capital, consistent with a coinsurance effect. Holding cash flows constant, our estimates imply an average value gain of approximately 5% when moving from the highest to the lowest cash flow correlation quintile.

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