Pyramidal Discounts: Tunneling or Overinvestment?

Owners exploit the strong separation between ownership and control in pyramiding to establish control over several firms' internal cash flows via a very small capital investment. We establish that the large discounts on the pyramid holding company as well as on the portfolio firms at the bottom are directly linked to costs from overinvestment that increase with the separation between ownership and control. In an economy where pyramids are transparent and the tax system regulates the flow of dividends within the pyramid and to shareholders, the primary cause of the discounts is not tunneling but overinvestment costs.