Robert Rosenberg in his comment on our paper makes a fundamental error regarding financial risk. (Rosenberg, "Unbundling Capital Costs: It Doesn't Add Up," Nov. 1, 1997, p. 46, responding to Maloney, McCormick, and Tyler, "The Wires Charge: Risk and Rates for the Regulated Distributor," Sept. 1, 1997, p. 26.)
Rosenberg claims that as utilities spin off into separate wires and generating businesses, risk will increase in both lines of business. He writes: "The mere act of splitting the business apart will make each of the newly formed independent segments riskier in the future¼ By disaggregating, companies will lose the benefits of intracompany diversification and vertical integration."
This statement is wrong. There are no risk-reducing benefits of integration. The fundamental theorem of finance says that all the benefits of risk reduction can be achieved by investors diversifying their portfolio of securities. There is no additional effect created when firms integrate. (See E.F. Fama and M.H. Miller, The Theory of Finance, 1972.)