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The Cost of Diversity: The Diversification Discount and Inefficient Investment

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  • RAGHURAM RAJAN
  • HENRI SERVAES
  • LUIGI ZINGALES

Abstract

We model the distortions that internal power struggles can generate in the allocation of resources between divisions of a diversified firm. The model predicts that if divisions are similar in the level of their resources and opportunities, funds will be transferred from divisions with poor opportunities to divisions with good opportunities. When diversity in resources and opportunities increases, however, resources can flow toward the most inefficient division, leading to more inefficient investment and less valuable firms. We test these predictions on a panel of diversified U.S. firms during the period from 1980 to 1993 and find evidence consistent with them. Copyright The American Finance Association 2000.

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Paper provided by Center for Research in Security Prices, Graduate School of Business, University of Chicago in its series CRSP working papers with number 357.

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Handle: RePEc:wop:chispw:357

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