Performance Effects of Diversification: Theory and Evidence on Importance of Nature of Information

Abstract

By definition, diversified corporations consist of several segments. By definition, venture capital firms consist of several segments, that is, funds, each of which has its own legal identity. Feasibility of coinvestments between funds that are managed by the same firm, but of which some are focused (`focused funds') on the technology sector, and others, either focused (for arrival at a `focused firm'), or `generalist' (for arrival at a `diversified firm') provides a unique opportunity for empirical tests of performance effects of corporate diversification. Study findings show, relative to focused firms, that diversified (hybrid) firms are associated with positive abnormal long-run exit performance. The finding that diversified firms take better advantage of arrival of positive shocks within investment opportunity sets of focused funds - an opportunity set held in common by focused and diversified firms - provides unambiguous evidence for efficiency of internal capital markets of diversified firms. Formal theoretical predictions and empirical findings show that while performance effects of corporate diversification align with performance effects of internal capital markets, the extant finding that diversification premiums align with dominance of the diversification structure (Santalo and Becerra 2008) lacks character of a necessary condition for efficiency of internal capital markets.