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Corporate Diversification and Agency

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  • Hermalin, Benjamin E.
  • Katz, Michael

Abstract

Firms undertake a variety of actions to reduce risk through diversification, including entering diverse lines of business, taking on project partners, and maintaining portfolios of risky projects such as R&D or natural resource exploration. By a well-known argument, securities holders do not directly benefit from risk-reducing corporate diversification when they can replicate this diversification on their own. Moreover, shareholders should be risk neutral with respect to the unsystematic risk that is associated with many research projects. Some have argued that corporate risk reduction may be of value, or can otherwise be explained by, the agency relationship between securities holders and managers. We argue that the value of diversification strategies in an agency relationship derives not from its effects on risk, but rather from its effects on the principal's information about the agent's actions. We demonstrate by example that diversification activities may increase or decrease the principal's information, depending on the particular structure of the activity

Suggested Citation

  • Hermalin, Benjamin E. & Katz, Michael, 2000. "Corporate Diversification and Agency," Research Program in Finance, Working Paper Series qt0p34c640, Research Program in Finance, Institute for Business and Economic Research, UC Berkeley.
  • Handle: RePEc:cdl:rpfina:qt0p34c640
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    Cited by:

    1. Perotti, Enrico C & von Thadden, Ernst-Ludwig, 2003. "The Political Economy of Bank and Equity Dominance," CEPR Discussion Papers 3914, C.E.P.R. Discussion Papers.
    2. Claessens, Stijn & Djankov, Simeon & Joseph P. H. Fan & Lang, Larry H. P., 1999. "Corporate diversification in East Asia : the role of ultimate ownership and group affiliation," Policy Research Working Paper Series 2089, The World Bank.
    3. Rosellon Cifuentes, M.A., 1999. "Essays on financial policy, liquidation values and product markets," Other publications TiSEM 802f644e-3e93-4815-bf33-8, Tilburg University, School of Economics and Management.
    4. Felipe Balmaceda, 2002. "Corporate Diversification: Good for Some Bad for Others," Documentos de Trabajo 141, Centro de Economía Aplicada, Universidad de Chile.
    5. Andriosopoulos, Dimitris & Andriosopoulos, Kostas & Hoque, Hafiz, 2013. "Information disclosure, CEO overconfidence, and share buyback completion rates," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5486-5499.
    6. Danso, Albert & Lartey, Theophilus & Amankwah-Amoah, Joseph & Adomako, Samuel & Lu, Qinye & Uddin, Moshfique, 2019. "Market sentiment and firm investment decision-making," International Review of Financial Analysis, Elsevier, vol. 66(C).
    7. Rizzo, Emanuele, 2018. "Essays on corporate governance and the impact of regulation on financial markets," Other publications TiSEM b5158260-ea13-4763-b992-6, Tilburg University, School of Economics and Management.
    8. Nancy L. Rose & Andrea Shepard, 1997. "Firm Diversification and CEO Compensation: Managerial Ability or Executive Entrenchment?," RAND Journal of Economics, The RAND Corporation, vol. 28(3), pages 489-514, Autumn.

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    More about this item

    Keywords

    diversification; principal-agent relationship;

    JEL classification:

    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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