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Short Sales Constraints and the Diversification Puzzle

Project Title: Short Sales Constraints and the Diversification Puzzle

PI: Pedro Saffi

Project Period: February 2016 - December 2017

We aim to explain the magnitude of the conglomerate discount, i.e. why diversified firms trade at a discount relative to focused ones. We build a model showing that investors disagree less about the valuation of a conglomerate than about its individual divisions. Disagreement, combined with the presence of short-sale constraints, increases asset prices and thereby implies a conglomerate discount. The model provides several testable implications about the incidence and size of the discount. Preliminary tests show that conglomerates face fewer short sales constraints and have less dispersion of opinion than focused firms, and the discount increases with short sales constraints and decreases with differences of opinion.

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