The underinvestment problem under conglomeration

This theoretical paper explores whether the underinvestment problem is aggravated or ameliorated by the formation of a pure conglomerate. It establishes that the answer depends critically on the volatility of corporate assets. If volatility is low, conglomeration ameliorates the underinvestment problem, whereas if volatility is high, conglomeration aggravates the underinvestment problem. These analytical results are then invoked as a potential explanation for the ambiguous conclusions of empirical studies that delve into the existence of a conglomerate discount.