Abstract
The effect of corporate diversification on firm performance has been extensively documented in the literature. In the general finance literature, Kuppuswamy and Villalonga (2015) studied the diversification effect during the 2007–2009 financial crisis and found that diversification adds value in the presence of external financing constraints. Motivated by this finding, we investigate whether a similar effect applies to insurance firms and we develop hypotheses for their different ownership structures (stock vs. mutual insurers; and group vs. non-group affiliated insurers). Using a sample of property-liability insurers over a period of 2004 to 2013, we find that the effect of diversification on performance is contingent on ownership structures and economic conditions. The diversification effect for stock insurers and insurers affiliated with a group is not significantly affected by economic conditions. However, the diversification effect for mutual insurers and non-affiliated insurers is reversed during the financial crisis. More specifically, diversified firms with these kinds of ownership structures perform better than focused firms during normal economic conditions, but their performance was significantly worse during the financial crisis. Our results are robust to alternative measures of performance and diversification, and to corrections for endogeneity. Our study contributes to the diversification literature by showing how the effect of diversification varies with ownership structure under different economic conditions and the results shed light on the specific circumstances in which diversification can improve or reduce performance.
Highlights
There is an extensive literature on the value of corporate diversification
This finding is consistent with our hypothesis H1a that the scarcity of internal resources and lack of investment opportunities during the financial crisis increases the costs of diversification for mutual insurers as they are less monitored than stock insurers
By focusing on the insurance industry, we benefit from the richness of the insurance statutory dataset and are able to explore the diversification effects on different ownership structures under different economic conditions
Summary
There is an extensive literature on the value of corporate diversification. Corporate diversification is associated with both costs and benefits and its average net effect is largely an empirical question. Kuppuswamy and Villalonga (2015) and Rudolph and Schwetzler (2013) study the value of diversification during the 2007–2009 global financial crisis, known as the Great Depression. They find that diversification adds value during the financial crisis and argue that corporate diversification can provide an important insurance function for investors. Kuppuswamy and Villalonga (2015) conclude that internal capital markets are more valuable and more efficient when external capital becomes more expensive They argue that the value of diversification increases during the financial crisis due to two effects that are not mutually exclusive but may complement each other. The “smarter money” effect implies that the relative value of internal capital markets increases when credit constraints are binding
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