Working Paper: CEPR ID: DP8105
Authors: Flavio Toxvaerd
Abstract: This work presents an equilibrium model of diversification through merger formation. Due to moral hazard problems, poorly capitalized firms are credit rationed and may seek to alleviate the incentive problem (and thereby raise external funds) by either merging, employing a monitor or a combination of the two. Within this setting, the effects on merger activity of different kinds of capital tightening are studied. In particular, credit crunches, collateral squeezes and savings squeezes are analyzed. The main results are that diversifying merger activity increases during times of economic expansion and is positively related to aggregate economic activity, business incorporations and easing of access to credit (both interest and non-interest terms of credit). Furthermore, the model offers a rationale for diversification that is immune to the diversification neutrality result and furthermore, explains why diversified companies trade at a discount relative to their non-diversified counterparts.
Keywords: Capital Tightening; Diversification; Diversification Discount; Financial Intermediation; Merger Waves; Mergers
JEL Codes: G34; L16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| economic expansion (F43) | diversifying merger activity (G34) |
| aggregate economic activity (E10) | diversifying merger activity (G34) |
| business incorporations (G30) | diversifying merger activity (G34) |
| easing access to credit (G21) | diversifying merger activity (G34) |
| diversifying mergers (G34) | debt capacity (G32) |
| firms with lower net worth (G32) | diversifying mergers (G34) |
| diversified companies (L22) | trade discount relative to non-diversified firms (L14) |