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A trade-off in corporate diversification

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  • Ekkayokkaya, Manapol
  • Paudyal, Krishna

Abstract

The marginal benefits of diversification exceed the costs by a decreasing margin, and diversifying beyond the optimal level will produce a wealth loss. This trade-off predicts an inverted U-relation between the degree of diversification and wealth. We find empirical evidence in support of this trade-off proposition. Consistent with the trade-off, firms diversify cautiously and stop diversifying before the marginal benefits are offset by the costs. Our findings lend support to the arguments suggesting efficient diversification. In line with the endogeneity of diversification, the findings also indicate that the optimal level of diversification can vary across firms depending on their reasons for diversifying.

Suggested Citation

  • Ekkayokkaya, Manapol & Paudyal, Krishna, 2015. "A trade-off in corporate diversification," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 275-292.
  • Handle: RePEc:eee:empfin:v:34:y:2015:i:c:p:275-292
    DOI: 10.1016/j.jempfin.2015.07.005
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    Keywords

    Corporate diversification; Benefits and costs of diversification; Non-linear wealth effect; Acquisitions;

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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