Conglomerate Entrenchment under Optimal Financial Contracting

Antoine Faure-Grimaud; Roman Inderst

doi:10.1257/0002828054201260

American Economic Review Vol. 95 No. 3 2005

Conglomerate Entrenchment under Optimal Financial Contracting

Antoine Faure-Grimaud¹; Roman Inderst²

¹ Department of Accounting and Finance, London School of Economics, Houghton Street, London WC2A 2AE and Centre for Economic Policy and Research. · ² INSEAD, Department of Finance, Boulevard de Constance, 77305 Fontainebleau Cedex, France, London School of Economics, and CEPR.

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Abstract

We provide a formal analysis of the notion that conglomerates are more ‘entrenched’ as they have ‘deeper pockets’. Using the financial contracting model of Bolton and Scharfstein (1990), we can isolate two effects that confirm this conjecture: the pooling of cash flows, which allows to smooth out repayments, and the ability to obtain better credit terms. For less profitable business segments, the internal capital market operated in a conglomerate may, however, work in the opposite direction, increasing the sensitivity of operations to own cash flows and increasing the likelihood of exit.

DOI: 10.1257/0002828054201260
Volume: 95
Issue: 3
Pages: 850-861
Language: en
Sources: bibtex:phds-export.bib openalex crossref

Conglomerate Entrenchment under Optimal Financial Contracting

Abstract

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