IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v111y2020ics0378426619303012.html
   My bibliography  Save this article

Capital structure and corporate diversification: Is debt a panacea for the diversification discount?

Author

Listed:
  • Fuente, Gabriel de la
  • Velasco, Pilar

Abstract

This study investigates the role of debt as an internal governance mechanism that can be employed by companies to curb agency conflicts and discourage managers from value-destroying diversification. Using a panel of U.S. firms, we find that leverage positively moderates the effect of diversification on a firm's value. We confirm that such an effect stems from the monitoring role of debt, which fosters efficiency in investments across segments and discourages cross-subsidization. Our investigation goes a step further by delving into the disciplinary role of debt and rationalizing certain scenarios that determine whether the effect of debt on the diversification-value relationship is stronger or weaker. We find such a moderating effect proves more beneficial for unrelated diversified companies and for firms with lower investment opportunities. However, the benefits of debt weaken in the presence of an alternative monitoring device (concentrated ownership), and when debt allocation becomes discretionary in highly diversified companies.

Suggested Citation

  • Fuente, Gabriel de la & Velasco, Pilar, 2020. "Capital structure and corporate diversification: Is debt a panacea for the diversification discount?," Journal of Banking & Finance, Elsevier, vol. 111(C).
    • Handle: RePEc:eee:jbfina:v:111:y:2020:i:c:s0378426619303012
    DOI: 10.1016/j.jbankfin.2019.105728
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378426619303012
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jbankfin.2019.105728?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Jacquemin, Alexis P & Berry, Charles H, 1979. "Entropy Measure of Diversification and Corporate Growth," Journal of Industrial Economics, Wiley Blackwell, vol. 27(4), pages 359-369, June.
    2. Glaser, Markus & Müller, Sebastian, 2010. "Is the diversification discount caused by the book value bias of debt?," Journal of Banking & Finance, Elsevier, vol. 34(10), pages 2307-2317, October.
    3. David J. Denis & Diane K. Denis & Keven Yost, 2002. "Global Diversification, Industrial Diversification, and Firm Value," Journal of Finance, American Finance Association, vol. 57(5), pages 1951-1979, October.
    4. Hoechle, Daniel & Schmid, Markus & Walter, Ingo & Yermack, David, 2012. "How much of the diversification discount can be explained by poor corporate governance?," Journal of Financial Economics, Elsevier, vol. 103(1), pages 41-60.
    5. Philip G. Berger & Rebecca Hann, 2003. "The Impact of SFAS No. 131 on Information and Monitoring," Journal of Accounting Research, Wiley Blackwell, vol. 41(2), pages 163-223, May.
    6. Stulz, ReneM., 1990. "Managerial discretion and optimal financing policies," Journal of Financial Economics, Elsevier, vol. 26(1), pages 3-27, July.
    7. Belén Villalonga, 2004. "Diversification Discount or Premium? New Evidence from the Business Information Tracking Series," Journal of Finance, American Finance Association, vol. 59(2), pages 479-506, April.
    8. Bover, Olympia & Watson, Nadine, 2005. "Are there economies of scale in the demand for money by firms? Some panel data estimates," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1569-1589, November.
    9. Harvey, Campbell R. & Lins, Karl V. & Roper, Andrew H., 2004. "The effect of capital structure when expected agency costs are extreme," Journal of Financial Economics, Elsevier, vol. 74(1), pages 3-30, October.
    10. Juan Santalo & Manuel Becerra, 2008. "Competition from Specialized Firms and the Diversification–Performance Linkage," Journal of Finance, American Finance Association, vol. 63(2), pages 851-883, April.
    11. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    12. Stephen A. Ross, 1977. "The Determination of Financial Structure: The Incentive-Signalling Approach," Bell Journal of Economics, The RAND Corporation, vol. 8(1), pages 23-40, Spring.
    13. William Ruland & Ping Zhou, 2005. "Debt, Diversification, and Valuation," Review of Quantitative Finance and Accounting, Springer, vol. 25(3), pages 277-291, November.
    14. Raphael Amit & Joshua Livnat, 1988. "Diversification strategies, business cycles and economic performance," Strategic Management Journal, Wiley Blackwell, vol. 9(2), pages 99-110, March.
    15. Zwiebel, Jeffrey, 1996. "Dynamic Capital Structure under Managerial Entrenchment," American Economic Review, American Economic Association, vol. 86(5), pages 1197-1215, December.
    16. Monika Schommer & Ansgar Richter & Amit Karna, 2019. "Does the Diversification–Firm Performance Relationship Change Over Time? A Meta‐Analytical Review," Journal of Management Studies, Wiley Blackwell, vol. 56(1), pages 270-298, January.
    17. Raghuram Rajan & Henri Servaes & Luigi Zingales, 2000. "The Cost of Diversity: The Diversification Discount and Inefficient Investment," Journal of Finance, American Finance Association, vol. 55(1), pages 35-80, February.
    18. Venkat Kuppuswamy & Belén Villalonga, 2016. "Does Diversification Create Value in the Presence of External Financing Constraints? Evidence from the 2007–2009 Financial Crisis," Management Science, INFORMS, vol. 62(4), pages 905-923, April.
    19. Brian K. Boyd & Steve Gove & Michael A. Hitt, 2005. "Consequences of measurement problems in strategic management research: the case of Amihud and Lev," Strategic Management Journal, Wiley Blackwell, vol. 26(4), pages 367-375, April.
    20. de Andrés, Pablo & de la Fuente, Gabriel & Velasco, Pilar, 2016. "Are real options a missing piece in the diversification-value puzzle?," International Review of Financial Analysis, Elsevier, vol. 48(C), pages 261-271.
    21. Trigeorgis, Lenos & Lambertides, Neophytos, 2014. "The Role of Growth Options in Explaining Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 49(3), pages 749-771, June.
    22. Stewart C. Myers, 2001. "Capital Structure," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 81-102, Spring.
    23. Gahlon, James M. & Stover, Roger D., 1979. "Diversification, Financial Leverage and Conglomerate Systematic Risk," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 14(5), pages 999-1013, December.
    24. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563, Elsevier.
    25. de Andrés, Pablo & de la Fuente, Gabriel & Velasco, Pilar, 2017. "Does it really matter how a firm diversifies? Assets-in-place diversification versus growth options diversification," Journal of Corporate Finance, Elsevier, vol. 43(C), pages 316-339.
    26. Guilhem Bascle, 2008. "Controlling for endogeneity with instrumental variables in strategic management research," Post-Print hal-00576795, HAL.
    27. Pindado, Julio & Requejo, Ignacio & de la Torre, Chabela, 2011. "Family control and investment–cash flow sensitivity: Empirical evidence from the Euro zone," Journal of Corporate Finance, Elsevier, vol. 17(5), pages 1389-1409.
    28. Harris, Milton & Raviv, Artur, 1990. "Capital Structure and the Informational Role of Debt," Journal of Finance, American Finance Association, vol. 45(2), pages 321-349, June.
    29. Leslie E. Palich & Laura B. Cardinal & C. Chet Miller, 2000. "Curvilinearity in the diversification–performance linkage: an examination of over three decades of research," Strategic Management Journal, Wiley Blackwell, vol. 21(2), pages 155-174, February.
    30. Sembenelli, Alessandro & Siotis, Georges, 2008. "Foreign Direct Investment and mark-up dynamics: Evidence from Spanish firms," Journal of International Economics, Elsevier, vol. 76(1), pages 107-115, September.
    31. repec:eee:labchp:v:3:y:1999:i:pb:p:2485-2563 is not listed on IDEAS
    32. Murray Z. Frank & Vidhan K. Goyal, 2009. "Capital Structure Decisions: Which Factors Are Reliably Important?," Financial Management, Financial Management Association International, vol. 38(1), pages 1-37, March.
    33. Maurizio La Rocca & Tiziana La Rocca & Dionigi Gerace & Ciorstan Smark, 2009. "Effect of diversification on capital structure," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 49(4), pages 799-826, December.
    34. Heitor Almeida & Murillo Campello & Antonio F. Galvao, 2010. "Measurement Errors in Investment Equations," The Review of Financial Studies, Society for Financial Studies, vol. 23(9), pages 3279-3328.
    35. Yakov Amihud & Baruch Lev, 1981. "Risk Reduction as a Managerial Motive for Conglomerate Mergers," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 605-617, Autumn.
    36. Fauver, Larry & Houston, Joel & Naranjo, Andy, 2003. "Capital Market Development, International Integration, Legal Systems, and the Value of Corporate Diversification: A Cross-Country Analysis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(1), pages 135-158, March.
    37. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, vol. 87(1), pages 115-143, August.
    38. Mitchell A. Petersen, 2009. "Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches," Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 435-480, January.
    39. Belén Villalonga, 2004. "Does Diversification Cause the "Diversification Discount"?," Financial Management, Financial Management Association, vol. 33(2), Summer.
    40. Manuel Ammann & Daniel Hoechle & Markus Schmid, 2012. "Is there Really No Conglomerate Discount?," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 39(1-2), pages 264-288, January.
    41. Gustavo Grullon & Evgeny Lyandres & Alexei Zhdanov, 2012. "Real Options, Volatility, and Stock Returns," Journal of Finance, American Finance Association, vol. 67(4), pages 1499-1537, August.
    42. Wintoki, M. Babajide & Linck, James S. & Netter, Jeffry M., 2012. "Endogeneity and the dynamics of internal corporate governance," Journal of Financial Economics, Elsevier, vol. 105(3), pages 581-606.
    43. Denis, David J & Denis, Diane K & Sarin, Atulya, 1997. "Agency Problems, Equity Ownership, and Corporate Diversification," Journal of Finance, American Finance Association, vol. 52(1), pages 135-160, March.
    44. Ahn, Seoungpil & Denis, David J. & Denis, Diane K., 2006. "Leverage and investment in diversified firms," Journal of Financial Economics, Elsevier, vol. 79(2), pages 317-337, February.
    45. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    46. Sattar A. Mansi & David M. Reeb, 2002. "Corporate Diversification: What Gets Discounted?," Journal of Finance, American Finance Association, vol. 57(5), pages 2167-2183, October.
    47. Del Viva, Luca & Kasanen, Eero & Trigeorgis, Lenos, 2017. "Real Options, Idiosyncratic Skewness, and Diversification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 52(1), pages 215-241, February.
    48. Jiraporn, Pornsit & Kim, Young Sang & Davidson, Wallace N. & Singh, Manohar, 2006. "Corporate governance, shareholder rights and firm diversification: An empirical analysis," Journal of Banking & Finance, Elsevier, vol. 30(3), pages 947-963, March.
    49. Yakov Amihud & Baruch Lev, 1999. "Does corporate ownership structure affect its strategy towards diversification?," Strategic Management Journal, Wiley Blackwell, vol. 20(11), pages 1063-1069, November.
    50. Servaes, Henri, 1996. "The Value of Diversification during the Conglomerate Merger Wave," Journal of Finance, American Finance Association, vol. 51(4), pages 1201-1225, September.
    51. Stein, Jeremy C., 2003. "Agency, information and corporate investment," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 2, pages 111-165, Elsevier.
    52. Yilei Zhang, 2009. "Are Debt and Incentive Compensation Substitutes in Controlling the Free Cash Flow Agency Problem?," Financial Management, Financial Management Association International, vol. 38(3), pages 507-541, September.
    53. Manuel Arellano & Stephen Bond, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 58(2), pages 277-297.
    54. Mitton, Todd & Vorkink, Keith, 2010. "Why Do Firms with Diversification Discounts Have Higher Expected Returns?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(6), pages 1367-1390, December.
    55. McConnell, John J. & Servaes, Henri, 1995. "Equity ownership and the two faces of debt," Journal of Financial Economics, Elsevier, vol. 39(1), pages 131-157, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Hossain, Mohammed Sawkat, 2021. "A revisit of capital structure puzzle: Global evidence and analysis," International Review of Economics & Finance, Elsevier, vol. 75(C), pages 657-678.
    2. Almaghrabi, Khadija S., 2022. "COVID-19 and the cost of bond debt: The role of corporate diversification," Finance Research Letters, Elsevier, vol. 46(PB).
    3. Feng, Yumei & Yao, Shouyu & Wang, Chunfeng & Liao, Jing & Cheng, Feiyang, 2022. "Diversification and financialization of non-financial corporations: Evidence from China," Emerging Markets Review, Elsevier, vol. 50(C).
    4. Azofra, Valentín & Rodríguez-Sanz, Juan Antonio & Velasco, Pilar, 2020. "The role of macroeconomic factors in the capital structure of European firms: How influential is bank debt?," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 494-514.
    5. Nur Mulyani Dwi Putri & Nurfauziah Nurfauziah, 2022. "The effect of ownership structure on the level of agency conflict: The moderating role of debt level," International Journal of Research in Business and Social Science (2147-4478), Center for the Strategic Studies in Business and Finance, vol. 11(5), pages 314-323, July.
    6. Velasco, Pilar, 2022. "Is bank diversification a linking channel between regulatory capital and bank value?," The British Accounting Review, Elsevier, vol. 54(4).
    7. Salama, Feras M. & Samet, Anis, 2022. "The impact of CEO inside debt on the coinsurance effect and excess value of diversification," International Review of Economics & Finance, Elsevier, vol. 81(C), pages 58-74.
    8. Viswanathan Nagarajan & Pitabas Mohanty & Apalak Khatua, 2023. "Financing effects of corporate diversification: A review," Review of Managerial Science, Springer, vol. 17(7), pages 2555-2585, October.
    9. Maisam Ali & Christopher Gan & Muhammad Nadeem, 2023. "A CEO's expertise power and bank diversification," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(4), pages 3815-3840, December.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Stefan Erdorf & Thomas Hartmann-Wendels & Nicolas Heinrichs & Michael Matz, 2013. "Corporate diversification and firm value: a survey of recent literature," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 27(2), pages 187-215, June.
    2. Zinnia Mitra Bose & Indrani Chakraborty, 2022. "Effects of diversification on firm performance: an analysis of Indian firms," Indian Economic Review, Springer, vol. 57(2), pages 469-511, December.
    3. de Andrés, Pablo & de la Fuente, Gabriel & Velasco, Pilar, 2017. "Does it really matter how a firm diversifies? Assets-in-place diversification versus growth options diversification," Journal of Corporate Finance, Elsevier, vol. 43(C), pages 316-339.
    4. Andreou, Panayiotis C. & Doukas, John A. & Koursaros, Demetris & Louca, Christodoulos, 2019. "Valuation effects of overconfident CEOs on corporate diversification and refocusing decisions," Journal of Banking & Finance, Elsevier, vol. 100(C), pages 182-204.
    5. Hoechle, Daniel & Schmid, Markus & Walter, Ingo & Yermack, David, 2012. "How much of the diversification discount can be explained by poor corporate governance?," Journal of Financial Economics, Elsevier, vol. 103(1), pages 41-60.
    6. de Andrés, Pablo & de la Fuente, Gabriel & Velasco, Pilar, 2016. "Are real options a missing piece in the diversification-value puzzle?," International Review of Financial Analysis, Elsevier, vol. 48(C), pages 261-271.
    7. Ji, Shuangshuang & Mauer, David C. & Zhang, Yilei, 2020. "Managerial entrenchment and capital structure: The effect of diversification," Journal of Corporate Finance, Elsevier, vol. 65(C).
    8. Stefan Erdorf & Thomas Hartmann-Wendels & Nicolas Heinrichs & Michael Matz, 2012. "Corporate Diversification and Firm Value: A Survey of Recent Literature," Cologne Graduate School Working Paper Series 03-01, Cologne Graduate School in Management, Economics and Social Sciences.
    9. Siraj, Ibrahim & Hassan, M. Kabir & Maroney, Neal, 2020. "Product demand sensitivity and the corporate diversification discount," Journal of Financial Stability, Elsevier, vol. 48(C).
    10. Hovakimian, Gayané, 2016. "Excess value and restructurings by diversified firms," Journal of Banking & Finance, Elsevier, vol. 71(C), pages 1-19.
    11. Glaser, Markus & Müller, Sebastian, 2006. "Der Diversification Discount in Deutschland : existiert ein Bewertungsabschlag für diversifizierte Unternehmen?," Papers 06-13, Sonderforschungsbreich 504.
    12. Elif AKBEN SELCUK, 2014. "Corporate Diversification, Group Affiliation and Firm Value: Evidence From Turkey," Journal of BRSA Banking and Financial Markets, Banking Regulation and Supervision Agency, vol. 8(2), pages 151-174.
    13. Nilakshi Borah & Liu Pan & Jung Chul Park & Nan Shao, 2018. "Does corporate diversification reduce value in high technology firms?," Review of Quantitative Finance and Accounting, Springer, vol. 51(3), pages 683-718, October.
    14. Maximilian Sturm & Stephan Nüesch, 2019. "Diversification and organizational environment: the effect of resource scarcity and complexity on the valuation of multi-segment firms," Journal of Business Economics, Springer, vol. 89(3), pages 251-272, April.
    15. Grass, Gunnar, 2010. "The impact of conglomeration on the option value of equity," Journal of Banking & Finance, Elsevier, vol. 34(12), pages 3010-3024, December.
    16. Mushtaq Hussain Khan & Hina Yaqub Bhatti & Arshad Hassan & Ahmad Fraz, 2021. "The diversification–performance nexus: mediating role of information asymmetry," Journal of Management & Governance, Springer;Accademia Italiana di Economia Aziendale (AIDEA), vol. 25(3), pages 787-810, September.
    17. Hoang, Khanh & Nguyen, Cuong & Zhang, Hailiang, 2021. "How does economic policy uncertainty affect corporate diversification?," International Review of Economics & Finance, Elsevier, vol. 72(C), pages 254-269.
    18. Szilagyi, P.G., 2007. "Corporate governance and the agency costs of debt and outside equity," Other publications TiSEM 9520d40a-224f-43a8-9bf9-b, Tilburg University, School of Economics and Management.
    19. Qiming Li & Wenhuan Wang & Yiping Lou & Ke Cheng & Xiaoguang Yang, 2016. "Diversification and Corporate Performance: Evidence from China’s Listed Energy Companies," Sustainability, MDPI, vol. 8(10), pages 1-17, September.
    20. Elena Alexandra Nenu & Georgeta Vintilă & Ştefan Cristian Gherghina, 2018. "The Impact of Capital Structure on Risk and Firm Performance: Empirical Evidence for the Bucharest Stock Exchange Listed Companies," IJFS, MDPI, vol. 6(2), pages 1-29, April.

    More about this item

    Keywords

    Corporate diversification; Capital structure; Agency theory; Overinvestment; Firm value;
    All these keywords.

    JEL classification:

    • C36 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Instrumental Variables (IV) Estimation
    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:111:y:2020:i:c:s0378426619303012. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jbf .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.