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The Cost of Diversity: The Diversification Discount and Inefficient Investment

Author

Listed:
  • 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.

Suggested Citation

  • 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, February.
    • Handle: RePEc:bla:jfinan:v:55:y:2000:i:1:p:35-80
    DOI: 10.1111/0022-1082.00200
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    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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