Why can't the market add and subtract? Evidence from central firms in business groups

We document 76 cases of blatant mispricing where market cap of the parent company is less than the total market value of the shares held in its public subsidiaries. Using business group data in Korea, we find that such extreme undervaluation is more likely when the firm is more ‘central’, i.e. more important in maintaining control of other member firms. Standard free float or illiquidity measures do not explain this mispricing when taken together with ‘centrality’. Our results suggest that business groups may generate limits to arbitrage where arbitrageurs are unable to purchase (all of) undervalued stocks.