Corporate Governance and Firm Diversification

We empirically investigate whether corporate governance structure is different between focused and diversified firms, and whether any differences in corporate governance are associated with the value loss from diversification. We find that, relative to focused firms, CEOs in diversified firms have lower stock ownership and lower pay-for-performance sensitivities. Diversified companies, however, have more outside directors, no difference in independent block-holdings, and sensitivity of CEO turnover to performance similar to that in single-segment firms. Moreover, we find no compelling evidence that internal governance failures are associated with the decision to diversify, or that governance characteristics explain the value loss from diversification. Our findings suggest that diversified firms use alternative governance mechanisms as substitutes for low pay-for-performance sensitivities and CEO ownership. We conclude that agency costs do not provide a complete explanation for the magnitude and persistence of the diversification discount.