Information Asymmetry and the Diversification Discount: Evidence from Listed Firms in China

Some firms adopt a strategy of business diversification, with the aim of increasing profitability through greater sales obtained from new product lines and expansion into new markets. However, extensive literatures from the U.S. have shown that, on average, diversification is a value-decreasing activity and firms with multi-segment businesses sell at a discount to non-diversified firms1 (see, for example, Gilson et al., 2001; Jensen, 1986; Myers and Majluf, 1984; Scharfstein, 1998). Although previous studies have examined differences in firm characteristics such as size, profitability, and leverage to explain the different valuations of diversified firms and focused firms, there is less empirical evidence on why this discount exists. One possible explanation for a discount is that corporate diversification is associated with a higher level of asymmetric information due to decreased transparency (Hadlock et al., 2001). We extend previous research by examining the relation between the diversification discount and the level of information asymmetry for firms listed in China’s stock market. We argue that the accounting figures of diversified firms are less transparent and less informative than those of the focused firms because of the aggregated nature of diversified firms’ consolidated accounting reports. Thus, investors tend to attach a lower level of credibility to the accounts of diversified firms.