Corporate Diversification and Overinvestment: Evidence from Asset Write-Offs

Abstract

This paper documents that diversified firms are more likely to overinvest than undiversified firms. Prior research on inefficient investment in diversified firms has been criticized on the measurement errors in measuring the unobservable marginal investment opportunities. Using an ex post measure of overinvestment that does not rely on investment opportunity set-asset write-offs, we find that diversified firms are more likely to incur tangible write-offs as well as goodwill write-offs and that the extent of the write-offs increases as firms become more diversified. In addition, we show that the diversification discount is related to subsequent asset write-offs, suggesting that diversified firms trade at a discount because investors expect overinvestment and correctly anticipate future write-offs.