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The Diversification Discount Puzzle: Empirical Evidence for a Transactions Cost Resolution

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  • Raj Aggarwal
  • Shelly Zhao

Abstract

Prior literature on the diversification discount and the relative efficiency of internal versus external capital markets provides decidedly mixed results. We argue that transactions cost economics are useful in understanding this puzzle. According to transactions cost economics, diversified firms should outperform single-segment firms in industries with higher external transaction costs (e.g., emergent industries). Similarly, single-segment firms should outperform diversified firms in industries with low external transactions costs and high agency and other internal costs (e.g., some mature industries). This paper provides empirical evidence supporting these contentions.

Suggested Citation

  • Raj Aggarwal & Shelly Zhao, 2007. "The Diversification Discount Puzzle: Empirical Evidence for a Transactions Cost Resolution," The Institute for International Integration Studies Discussion Paper Series iiisdp222, IIIS.
  • Handle: RePEc:iis:dispap:iiisdp222 Note: Length:
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    2. Aggarwal, Raj & Goodell, John W., 2011. "International variations in expected equity premia: Role of financial architecture and governance," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 3090-3100, November.
    3. Aggarwal, Raj & Goodell, John W., 2014. "Cross-national differences in access to finance: Influence of culture and institutional environments," Research in International Business and Finance, Elsevier, vol. 31(C), pages 193-211.
    4. Aggarwal, Raj & Goodell, John W., 2010. "Financial markets versus institutions in European countries: Influence of culture and other national characteristics," International Business Review, Elsevier, vol. 19(5), pages 502-520, October.
    5. Aggarwal, Raj & Goodell, John W., 2009. "Markets and institutions in financial intermediation: National characteristics as determinants," Journal of Banking & Finance, Elsevier, vol. 33(10), pages 1770-1780, October.

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    Keywords

    Diversification; transaction cost economics; internal markets;

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