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Efficiency Implications of Corporate Diversification: Evidence from Micro Data

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Author Info
Ekaterina Emm
Jayant Kale
Abstract

In this study, we contribute to the ongoing research on the rationales for corporate diversification. Using plant-level data from the U.S. Census Bureau, we examine whether combining several lines of business in one entity leads to increased productive efficiency. Studying the direct effect of diversification on efficiency allows us to discern between two major theories of corporate diversification: the synergy hypothesis and the agency cost hypothesis. To measure productive efficiency, we employ a non-parametric approach—a test based on Varian’s Weak Axiom of Profit Maximization (WAPM). This method has several advantages over other conventional measures of productive efficiency. Most importantly, it allows one to perform the efficiency test without relying on assumptions about the functional form of the underlying production function. To the best of our knowledge, this study is the first application of the WAPM test to a large sample of non-financial firms. The study provides evidence that business segments of diversified firms are more efficient compared to single-segment firms in the same industry. This finding suggests that the existence of the so-called ‘diversification discount’ cannot be explained by efficiency differences between multi-segment and focused firms. Furthermore, more efficient segments tend to be vertically integrated with others segments in the same firm and to have been added through acquisitions rather than grown internally. Overall, the results of this study indicate that corporate diversification is value-enhancing, and that it is not necessarily driven by managers’ pursuit of their private benefits.

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File URL: http://www.ces.census.gov/index.php/ces/cespapers?down_key=101766
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File Function: First version, 2006
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Publisher Info
Paper provided by Center for Economic Studies, U.S. Census Bureau in its series Working Papers with number 06-26.

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Length: 69 pages
Date of creation: Nov 2006
Date of revision:
Handle: RePEc:cen:wpaper:06-26

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Web page: http://www.ces.census.gov

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Related research
Keywords: Restructuring; Diversification; Efficiency;

Find related papers by JEL classification:
D2 - Microeconomics - - Production and Organizations
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing
G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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