Diversification in Firm Valuation: A Multivariate Copula Approach

Stefan Erdorf, Thomas Hartmann-Wendels, Nicolas Heinrichs
2011 Social Science Research Network  
We introduce a new discounted cash flow model which adopts the diversification effect of multi-business firms. We face two challenges: One is examining how different diversification extents can affect the firm value due to risk reduction, and the other is modeling segment-specific cash flows and discount rates to reflect the differences in risk and growth characteristics across the different businesses that a firm operates in. Since the co-movement of business segments depends on the state of
more » ... e economy, we use a multivariate copula approach taking the state-varying dependence of business segments explicitly into account. A high level of a firm's diversification determined by a low dependence between the firm's business segments leads to a lower probability of firm default which results in a higher firm value through reduced bankruptcy costs. We demonstrate this effect by comparing the values of three U.S. firms when modeling independence, dependence with copulas, and perfect dependence between businesses. JEL-Classification: G11, G17, G33, L25
doi:10.2139/ssrn.1739736 fatcat:2jaswidwczd7lajmfa5e7ed3pq