Effect Of Corporate Diversification Research Articles

Entrenched controlling shareholders and the performance consequences of corporate diversification in Taiwan

The main purpose of this paper is to examine the value/performance effects of corporate diversification in an emerging market. Prior evidence on this issue is still mixed. The present study adds the role of entrenched controlling shareholders into this issue. We argue that when controlling shareholders have larger excess board seats control rights, they have higher ability and incentive to expropriate minority shareholders through corporate diversification. Using a sample of firms listed on the Taiwan Stock Exchange in 2003, we find that controlling shareholders’ excess board seats control is negatively associated with the market valuation of corporate diversification. Consistently, we also document that highly diversified firms run by more entrenched controlling shareholders have lower future financial performance than otherwise similar firms. Overall, our findings imply that corporate diversification is not necessarily harmful or beneficial for firms. We conclude that the agency problem arising from the excess board seats control rights owned by controlling shareholders is an influential factor leading to negative performance consequences with regard to firm diversification.

Effects of Corporate Diversification: Evidence From the Property–Liability Insurance Industry

AbstractUsing a sample of property–liability insurers over the period 1995–2004, we develop and test a model that explains performance as a function of line‐of‐business diversification and other correlates. Our results indicate that undiversified insurers consistently outperform diversified insurers. In terms of accounting performance, we find a diversification penalty of at least 1 percent of return on assets or 2 percent of return on equity. These findings are robust to corrections for potential endogeneity bias, alternative risk measures, alternative diversification measures, and an alternative estimation technique. Using a market‐based performance measure (Tobin's Q) we find that the market applies a significant discount to diversified insurers. The existence of a diversification penalty (and diversification discount) provides strong support for the strategic focus hypothesis. We also find that insurance groups underperform unaffiliated insurers and that stock insurers outperform mutuals.

Diversification discount, information rents, and internal capital markets

While many existing studies report that corporate diversification destroys shareholder value, several recent studies challenge these findings. Schoar [Schoar, A. (2002). Effects of corporate diversification on productivity. The Journal of Finance, 57, 2379−2403] finds that plants in conglomerates are more productive than those in comparable single-segment firms, although conglomerates are traded at discounts. Villalonga [Villalonga, B. (2004a). Diversification discount or premium? New evidence from the business information tracking services. The Journal of Finance, 59, 479–506; Villalonga, B. (2004b). Does diversification cause the “diversification discount”. Financial Management, 33, 5−27] employs a more comprehensive database and statistical techniques than those used in the prior studies, and shows that there is a diversification premium, rather than discount. This paper develops a model that highlights the costs and benefits of corporate diversification. The diversified firm trades off the benefits of more efficient resource allocation through its internal capital market against the costs of information rents to division managers, which are necessary for effective workings of the internal capital market. We provide an argument supporting Schoar's findings, and identify conditions under which there can be a diversification discount or a premium.

Corporate Diversification and Credit Risk

Existing literature has documented a lot of research efforts on the issues of corporate diversification discount and diversification premium, most of them trying to explain the rationales why firms diversify or focus, especially to unveil the benefits and costs of their diversification decisions. However, few of them explore the relationship between corporate diversification and corporate credit risk. It is the purpose of this study to investigate the effects of corporate diversification on both credit risk and firm value using American firms engaged in mergers and acquisitions from 1980 to 2005. In this study, we calculate a firm's one year default probability according to Black-Scholes (1973) and Merton (1974) and we follow both Berger and Ofek (1995) and Mansi and Reeb (2002) to calculate the excess firm values. We obtain several interesting findings. First, we observe that according to levels of credit quality, the changes in default probability move in different directions when firms diversify. Default probabilities of risky firms decline when diversifying, which is consistent with coinsurance effect and risk effect, while, on the contrary, those of safe firms increase, which violates the hypothesis of coinsurance effect. It can be explained by a strong risk effect suggested by Billett, King, and Mauer (2004). Second, market values of equity move in the same direction with default probabilities. It is consistent with the option theory based credit model originated by Black-Scholes (1973) and Merton (1974). We find that risky firms bear diversification discount and safe firms enjoy diversification premium when we only consider the wealth changes of stockholders. Finally, we provide empirical evidences for wealth transfer effect and show that the directions of the transfer are opposite according to the credit quality of diversifying firms.

Effects of Corporate Diversification on Productivity

Using plant‐level observations from the Longitudinal Research Database I show that conglomerates are more productive than stand‐alone firms at a given point in time. Dynamically, however, firms that diversify experience a net reduction in productivity. While the acquired plants increase productivity, incumbent plants suffer. Moreover, stock prices track firm productivity and this tracking is equally strong for diversified and stand‐alone firms. Therefore, lower transparency of conglomerates is unlikely to explain the discrepancy between productivity and stock prices on average. Finally, I offer some evidence that this discrepancy may arise because conglomerates dissipate rents in the form of higher wages.

Corporate Diversification: What Gets Discounted?

ABSTRACTPrior literature finds that diversified firms sell at a discount relative to the sum of the imputed values of their business segments. We explore this documented discount and argue that it stems from risk‐reducing effects of corporate diversification. Consistent with this risk‐reduction hypothesis, we find that (a) shareholder losses in diversification are a function of firm leverage, (b) all equity firms do not exhibit a diversification discount, and (c) using book values of debt to compute excess value creates a downward bias for diversified firms. Overall, the results indicate that diversification is insignificantly related to excess firm value.

Corporate Diversification: What Gets Discounted?

Prior literature finds that diversified firms sell at a discount relative to the sum of the imputed values of their business segments. We explore this documented diversification discount and argue that it stems from the risk reducing effects of corporate diversification. Consistent with this risk reduction hypothesis, we find that (i) shareholder losses in diversification are a function of firm leverage, (ii) all equity firms do not exhibit a diversification discount, and (iii) using book values of debt to compute excess value creates a downward bias for diversified firms. When considering the joint impact to both debt and equity holders, we find that, on average, diversification is insignificantly related to excess firm value.

The effect of corporate diversification and business unit strategy on the presence of slack in business unit budgets

This study examines how two important situational factors (corporate diversification and business unit strategy) and two elements of a firm’s administrative system (accounting‐based budgetary controls and associated incentives) affect the presence of slack in business unit budgets in diversified firms. The relationships among these variables are established by building on theories from organizational economics, the information‐processing view of organizations, and organizational behavior. Data are collected from 37 firms and 153 business units within these firms. The main results indicate: that corporate diversification is positively associated with slack in business unit budgets; and that tight budgetary controls and high‐powered incentives effectively curtail such slack. However, diversification does not seem to drive corporate managers to rely more on these systems to reduce higher budgetary slack associated with diversification. This suggests: that diversified firms employ a conscious strategy of slack at the business unit level to reduce information‐processing needs at the top; or that the design of the internal management control system is a function of factors other than corporate diversification. With respect to the latter explanation, the results indicate that business units that pursue a differentiation strategy receive less tight budgetary controls, which leaves them with the necessary slack to effectively pursue the critical success factors on which their strategies are built.

Corporate Structure and Equity Offerings: Are There Benefits to Diversification?

In this paper we examine the effect of corporate diversification on the equity issue process. In a sample of 641 equity issues conducted over the 1983-1994 time period, we find evidence that equity issues by diversified firms are viewed less negatively by the market than are equity issues by comparable focused firms. This finding is consistent with the hypothesis that diversification helps alleviate the asymmetric information problem when raising equity, a possibility that we formally model. Our results are inconsistent with the hypothesis that valuation problems exacerbate the asymmetric information problem for diversified firms. Additionally, our results appear to be inconsistent with the hypothesis that the market views equity issues by diversified firms as a particularly strong indication that the firm will invest in poor projects.

In Search of Synergy: A Structure-Performance Test

T HE conglomerate activity of the sixties has generated considerable interest in the effects of corporate diversification. Enquiry has centered on two related questions-how well do diversified firms perform vis-a-vis specialized companies, and if they perform differently, why do they do so? With respect to these questions, this paper presents qualified evidence which suggests that diversified firms outperform their specialized counterparts, other things equal, and that the source of the superior performance is the synergy that arises from diversification.'