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The Boundaries of the Firm: The Choice Between Stand‐Alone and Integrated Firms
Author(s) -
Berkovitch Elazar,
Israel Ronen,
Tolkowsky Efrat
Publication year - 2006
Publication title -
journal of economics and management strategy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.672
H-Index - 68
eISSN - 1530-9134
pISSN - 1058-6407
DOI - 10.1111/j.1530-9134.2006.00119.x
Subject(s) - divestment , yardstick , principal–agent problem , industrial organization , business , competition (biology) , microeconomics , theory of the firm , agency (philosophy) , economics , finance , corporate governance , ecology , philosophy , geometry , mathematics , epistemology , biology
This study presents a theory of corporate structure selection. It outlines when economic units should be structured as stand‐alone firms versus an integrated firm (conglomerate). The theory suggests that an integrated firm better controls agency problems through yardstick competition between managers for project acceptance. However, this structure reduces the ability to receive division‐specific project information from the market. Based on this trade‐off, we show that divisions within a conglomerate have different characteristics and, thus, different valuations than “similar” stand‐alone firms. Our theory also explains differences in the required rate of return between stand‐alone firms and conglomerates and how they relate to relative valuations of conglomerates and “similar” stand‐alone firm. It also predicts when stock price reaction to divestiture and merger announcements will be positive or negative.