Can Diversification Create Value? Evidence from the Electric Utility Industry

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Can Diversification Create Value? Evidence from the Electric Utility Industry

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Jandik, Tomas (U of Arkansas)
Makjija, Anil K. (Ohio State U)

Abstract

Despite SEC and state-level resistance, and contrary to the trend pursued by other firms, many electric utilities have diversified into non-electric and unregulated businesses. Moreover, this failure to focus has been rewarded with higher firm values, again contrary to the discounts documented in the literature for other diversifying firms. Prior literature has questioned whether these premiums (or discounts) can be attributed to diversification per se. Rather, these premiums could arise from the characteristics of the diversifying firms, which have then endogenously chosen to diversify. In a new approach, where regulation can make the diversification decision largely exogenous, we examine the investment policies of the comparable electric-segments in the diversifying and non-diversifying utilities. We find that single-segment electric utilities over-invest compared to diversifying utilities, which explains their diversification premiums and implies that diversification can create value by opening up new investment opportunities.

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Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2005-7.

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Date of creation: Dec 2004
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Handle: RePEc:ecl:ohidic:2005-7

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G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy

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