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The Berger and Ofek (1995) excess value measure, comparing a conglomerate's actual market value to an imputed value based on standalones, has become the standard method to determine value effects of diversification. In this paper, we address a significant bias in this procedure stemming from the difference in cash holdings between diversified and standalone firms. Excess values are based on firm values, including corporate cash positions. As standalones hold significantly more cash, the imputed cash value is higher than the conglomerate's actual cash value, resulting in a downward biased excess value. We thus propose to calculate excess values based on enterprise values, replacing total debt by net debt. Based on an extensive U.S. sample, we show that there is significantly less evidence of a diversification discount when adjusting for the cash bias. In terms of average dollar losses, the firm value-based models overestimate the conglomerate discount by at least 25%. Apart from removing the cash bias, we propose a second modification to the excess value measure, arguing that standalone industry multipliers should be calculated using geometric mean aggregation instead of median aggregation._x000D_ This working paper was published in the Journal of Banking and Finance, 40 (2014), 3.

We promote the Oaxaca-Blinder decomposition as a new empirical approach to corporate finance-related research. Originated in labor economics, its primary field ofapplication is the examination of gender and race-related wage gaps. Allowing for an in-depth analysis of factors driving valuation differences between two distinctive groups, the method likewise provides an effective tool for corporate finance topics. We demonstrate its usefulness on the basis of an old yet still up-to-date problem, namelythe value discount associated with corporate diversification. In particular, we aim to disentangle how the different agency conflicts - the one between the corporate manager and shareholders and the other between majority and minority shareholders - work on the discount. Using a sample of CDAX firms from 2000 to 2009, we find the latter conflict to be the driving agency-related cost.

Market sentiment has swung in favor of diversified companies, which is reflected in the decline of the conglomerate discount. One reason for this shift is that diversified companies have a financial advantage over their focused peers during crises. However, only some diversified companies turn this advantage into a competitive edge.