Does CEO overconfidence help to explain merger decisions? Overconfident CEOs overestimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing. We test these predictions using two proxies for overconfidence: CEOs' personal overinvestment in their company and their press portrayal. We find that the odds of making an acquisition are 65 % higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing. The market reaction at merger announcement (–90 basis points) is significantly more negative than for non-overconfident CEOs (–12 basis points). We consider alternative interpretations including inside information, signaling, and risk tolerance.

I use the Business Information Tracking Series (BITS), a new census database that covers the whole U.S. economy at the establishment level, to examine whether the finding of a diversification discount is an artifact of segment data. BITS data allow me to construct business units that are more consistently and objectively defined than segments, and thus more comparable across firms. Using these data on a sample that yields a discount according to segment data, I find a diversification premium. The premium is robust to variations in the sample, business unit definition, and measures of excess value and diversification. THE DIVERSIFICATION DISCOUNT has been the subject of an active debate in corporate finance during the past few years. 1 On the one hand, Lang and Stulz (1994), Berger and Ofek (1995), and Servaes (1996) find that diversified firms trade at an average discount relative to single-segment firms. This finding has often been interpreted as evidence that diversification destroys value. 2 On the other hand, several studies show that the discount is only the product of sample selection biases. Villalonga (1999) and Campa and Kedia (2002) find that diversified firms traded at a discount prior to diversifying. More generally, diversifying and nondiversifying firms differ systematically in multiple characteristics. When the selection bias is corrected for, the diversification discount

This paper examines the factors that lead to the creation of venture capital-backed entrepreneurs, a process we term “entrepreneurial spawning. ” We contrast two alternative views of the spawning process. In one view, employees of established firms are trained and conditioned to be entrepreneurs by being exposed to the entrepreneurial process and by working in a network of entrepreneurs and venture capitalists. Alternatively, individuals become entrepreneurs because the large bureaucratic companies for which they work are reluctant to fund their entrepreneurial ideas. After controlling for a variety of firm characteristics including its patent portfolio and industry, we find that the most prolific spawning firms were public companies located in Silicon Valley and Massachusetts that were themselves once VC-backed. Less diversified firms are also more likely to spawn new firms. Spawning levels for these firms rise as their sales growth declines. Overall, these findings appear to be more consistent with the view that entrepreneurial learning and networks are important factors in the creation of venture-capital backed firms.

This paper shows that the amount of capital reallocation between firms is procyclical. In contrast, the benefits to capital reallocation appear countercyclical. We measure the amount of reallocation using data on flows of capital across firms and the benefits to capital reallocation using several measures of the cross sectional dispersion of the productivity of capital. We then study a calibrated model economy where capital reallocation is costly and impute the cost of reallocation. We find that the cost of reallocation needs to be substantially countercyclical to be consistent with the observed joint cyclical properties of reallocation and productivity dispersion. JEL Classification: E22; E32; E44; G34

The existing literature on firms, based on incomplete contracts and property rights, emphasizes that the ownership of assets- and thereby firm boundaries- is determined in such a way as to encourage relationship-specific investments by the appropriate parties. It is generally accepted that this approach applies to ownermanaged firms better than to large companies. In this paper, we attempt to broaden the scope of the property rights approach by developing a simple model with three key ingredients: (a) decision rights can be transferred ex ante through ownership, (b) managers (and possibly workers) enjoy private benefits that are non-transferable, and (c) owners can divert a firm’s profit. In our basic model decisions are ex post non-contractible; in an extension we use the idea that contracts are reference points to relax this assumption. We show that firm boundaries matter. Nonintegrated firms fail to account for the external effects that their decisions have on other firms. An integrated firm can internalize such externalities, but it does not put enough weight on the private benefits of managers and workers. We explore this tradeoff in a model that focuses on the

We demonstrate that limited market participation can arise endogenously in the presence of model uncertainty. Our model generates novel predictions on the relation between limited market participation, equity premium, and diversification discount. When the dispersion in investors ’ model uncertainty is small, full market participation prevails in equilibrium. In this case, equity premium is unrelated to model uncertainty dispersion and a conglomerate trades at a price equal to the sum of its single segment counterparts. When model uncertainty dispersion is large, however, investors with high uncertainty optimally choose to stay sidelined in equilibrium. In this case, equity premium can decrease with model uncertainty dispersion. This is in sharp contrast to the understanding in the existing literature that limited market participation leads to higher equity premium. Moreover, when limited market participation occurs, a conglomerate trades at a discount relative to its single segment counterparts. The discount increases in model uncertainty dispersion and is positively related to the proportion of investors not participating in the markets.

associates with the National Bureau of Economic Research, and Davis is a Visiting

We examine the effect of financial dependence on the acquisition and investment of singlesegment and conglomerate firms at different stages of the industry life cycle. Conglomerates and single-segment firms differ in acquisition activity more than in the level of capital expenditure across all stages. Financial dependence, a deficit in a segment’s internal financing, decreases the likelihood of acquisitions and opening new plants, especially for single-segment firms. In growth industries, these effects are mitigated for conglomerates and public firms. In declining industries, plants of segments that are financially dependent are less likely to be closed by conglomerate firms. These findings persist after controlling for public status, firm size and segment productivity. We also find that plants acquired by conglomerate firms in growth industries increase in productivity post-acquisition. The results are consistent with the conclusion that the comparative advantages of different firm organizations differ across the industry life cycle.

Empirical studies on the importance of control rights on efficiency are hindered by actual –presumably efficient – ownership patterns. Finding settings where the right owner does not own the right asset and where ownership arbitrarily changes is challenging. In this paper I aim at overcoming these problems by investigating the elimination of foreign majority ownership restrictions in Mexico. Specifically, I study the performance of affiliates of multinational corporations for which (1) ownership restrictions appeared to bind before they were lifted, and (2) parent ownership increased from minority to majority as the reform was implemented. Using detailed plant-level information, I find that multinational control leads to large improvements in total factor productivity, particularly in industries that rely on technological innovations from their parent companies. Control is also associated with higher investment –particularly in technology intensive forms of production–, and with an improvement in the skill profile of the labor force. Overall, I interpret the evidence as supportive of the property rights theory of the firm.

This paper studies announcement returns in a sample of 3,667 mergers over the last 55 years in order to shed light on the causes of the waning of corporate diversification. The abnormal combined (acquirer + target) return from diversifying mergers declined over time, consistent with the idea that diversification fell from favor in the 1980s. The market rewarded mergers involving financially constrained firms before but not after 1980, consistent with a declining value of internal capital markets. Announcement returns changed less for large firms than small firms, suggesting antitrust was not a key factor. Diversifying mergers earned positive combined returns throughout the period, and bidder returns were nonnegative before 1980, suggesting diversification was not a valuedestroying outgrowth of agency problems.