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The Cost of Diversity: The Diversification Discount and Inefficient Investment

  • Raghuram Rajan

    (University of Chicago,)

  • Henri Servaes

    (London Business School and University of North Carolina at Chapel Hill)

  • Luigi Zingales

    (University of Chicago,)

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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Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 55 (2000)
Issue (Month): 1 (02)
Pages: 35-80

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Handle: RePEc:bla:jfinan:v:55:y:2000:i:1:p:35-80
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