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Does Diversification Destroy Value? Evidence from Industry Shocks."

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  • OWEN A. 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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Paper provided by Center for Research in Security Prices, Graduate School of Business, University of Chicago in its series CRSP working papers with number 521.

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Handle: RePEc:wop:chispw:521

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  1. Owen Lamont & Christopher Polk, 1999. "The Diversification Discount: Cash Flows vs. Returns," NBER Working Papers 7396, National Bureau of Economic Research, Inc.
  2. Raghuram Rajan & Henry Servaes & Luigi Zingales, . "The Cost of Diversity: The Diversification Discount and Inefficient Investment," CRSP working papers 463, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  3. 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.
  4. 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.
  5. 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.
  6. Lamont, Owen, 1997. " Cash Flow and Investment: Evidence from Internal Capital Markets," Journal of Finance, American Finance Association, vol. 52(1), pages 83-109, March.
  7. 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.
  8. Morck, Randall & Shleifer, Andrei & Vishny, Robert W, 1990. " Do Managerial Objectives Drive Bad Acquisitions?," Journal of Finance, American Finance Association, vol. 45(1), pages 31-48, March.
  9. Berger, Philip G. & Ofek, Eli, 1995. "Diversification's effect on firm value," Journal of Financial Economics, Elsevier, vol. 37(1), pages 39-65, January.
  10. Steven Kaplan & Michael S. Weisbach, 1992. "The Success of Acquisitions: Evidence From Disvestitures," NBER Working Papers 3484, National Bureau of Economic Research, Inc.
  11. 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.
  12. 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.
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Cited by:
  1. 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.
  2. Laeven, Luc, 2001. "International evidence on the value of product and geographic diversity," Policy Research Working Paper Series 2729, The World Bank.
  3. Jeremy C. Stein, 2001. "Agency, Information and Corporate Investment," NBER Working Papers 8342, National Bureau of Economic Research, Inc.
  4. Frédéric Perdreau, 2002. "Searching for managerial opportunism faint traces in French diversifying acquisitions," Post-Print halshs-00010010, HAL.
  5. 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.

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