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Shares of diversified firms and pure play firms

Why might the market discount the shares of a diversified firm relative to a set of pure play firms?

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Source: http://www.haskayne.ucalgary.ca/research/media/2002_17.pdf

Why might the market discount the shares of a diversified firm relative to a set of pure play firms?

The view of the effect of diversification on value has changed over the years. Earlier diversified conglomerates were viewed as adding value through operating and financial synergies. In particular, a diversified firm provided an internal capital market that was believed to be more efficient than external capital markets since it avoided market transactions costs and informational asymmetries. This view on diversification as enhancing value of the firm was prevalent in the 1960s and 1970s during which time, conglomerates actually traded at relative premiums. During the 1980s, there was a turn around in the perception of diversification. ...

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The solution attempts to answer the question why might the market discount the shares of a diversified firm relative to a set of pure play firms.

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