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Does Diversification Destroy Value? Evidence From Industry Shocks

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  • Owen Lamont
  • Christopher Polk

Abstract

Does corporate diversification reduce shareholder value? Since firms endogenously choose to diversify, exogenous variation in diversification is necessary in order to draw inferences about the causal effect. We examine changes in the within-firm dispersion of industry investment, or diversity.' We find that exogenous changes in diversity, due to changes in industry investment, are negatively related to firm value. Thus diversification destroys value, consistent with the inefficient internal capital markets hypothesis. This finding is not caused by measurement error. We also find that exogenous changes in industry cash flow diversity are negative related to firm value.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7803.

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Date of creation: Jul 2000
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Publication status: published as Lamont, Owen A. and Christopher Polk. "Does Diversification Destroy Value? Evidence From The Industry Shocks," Journal of Financial Economics, 2002, v63(1,Jan), 51-77.
Handle: RePEc:nbr:nberwo:7803

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  1. 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, 02.
  2. 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 135-60, March.
  3. Randall Morck & Andrei Shleifer & Robert W. Vishny, 1989. "Do Managerial Objectives Drive Bad Acquisitions?," NBER Working Papers 3000, National Bureau of Economic Research, Inc.
  4. Owen Lamont, 1996. "Cash Flow and Investment: Evidence from Internal Capital Markets," NBER Working Papers 5499, National Bureau of Economic Research, Inc.
  5. Hyun-Han Shin & René M. Stulz, 1998. "Are Internal Capital Markets Efficient?," The Quarterly Journal of Economics, MIT Press, vol. 113(2), pages 531-552, May.
  6. Olivier J. Blanchard & Florencio Lopez-de-Silane, 1993. "What do Firms do with Cash Windfalls?," NBER Working Papers 4258, National Bureau of Economic Research, Inc.
  7. Owen Lamont & Christopher Polk, 1999. "The Diversification Discount: Cash Flows vs. Returns," NBER Working Papers 7396, National Bureau of Economic Research, Inc.
  8. Kaplan, Steven N & Weisbach, Michael S, 1992. " The Success of Acquisitions: Evidence from Divestitures," Journal of Finance, American Finance Association, vol. 47(1), pages 107-38, March.
  9. Stein, Jeremy C, 1997. " Internal Capital Markets and the Competition for Corporate Resources," Journal of Finance, American Finance Association, vol. 52(1), pages 111-33, March.
  10. Berger, Philip G. & Ofek, Eli, 1995. "Diversification's effect on firm value," Journal of Financial Economics, Elsevier, vol. 37(1), pages 39-65, January.
  11. Larry H.P. Lang & Rene M. Stulz, 1993. "Tobin's Q, Corporate Diversification and Firm Performance," NBER Working Papers 4376, National Bureau of Economic Research, Inc.
  12. Fluck, Zsuzsanna & Lynch, Anthony W, 1999. "Why Do Firms Merge and Then Divest? A Theory of Financial Synergy," The Journal of Business, University of Chicago Press, vol. 72(3), pages 319-46, July.
  13. Jose Manuel Campa & Simi Kedia, 2002. "Explaining the Diversification Discount," Journal of Finance, American Finance Association, vol. 57(4), pages 1731-1762, 08.
  14. Lewellen, Wilbur G, 1971. "A Pure Financial Rationale for the Conglomerate Merger," Journal of Finance, American Finance Association, vol. 26(2), pages 521-37, May.
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Cited by:
  1. Frédéric Perdreau, 2002. "Searching for managerial opportunism faint traces in French diversifying acquisitions," Post-Print halshs-00010010, HAL.
  2. Berger, Allen N. & Hasan, Iftekhar & Korhonen, Iikka & Zhou, Mingming, 2010. "Does diversification increase or decrease bank risk and performance? Evidence on diversification and the risk-return tradeoff in banking," BOFIT Discussion Papers 9/2010, Bank of Finland, Institute for Economies in Transition.
  3. Jeremy C. Stein, 2001. "Agency, Information and Corporate Investment," NBER Working Papers 8342, National Bureau of Economic Research, Inc.
  4. Martin, John D. & Sayrak, Akin, 2003. "Corporate diversification and shareholder value: a survey of recent literature," Journal of Corporate Finance, Elsevier, vol. 9(1), pages 37-57, January.
  5. Laeven, Luc, 2001. "International evidence on the value of product and geographic diversity," Policy Research Working Paper Series 2729, The World Bank.

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