Corporate diversification

Garrett C.C. Smith and Jeffrey M. Coy

Review of Accounting and Finance, 2018, vol. 17, issue 3, 405-424

Abstract: Purpose - The purpose of this study is to compare two theories that relate the proportion of diversified firms in the economy and the implied discount for diversified firms: the first is a real-options model predicting a positive relationship between the discount and management’s choice to operate a diversified firm; the second is based on catering theory, in which a negative relationship is predicted, as management is attentive to investor preference concerning diversified firms. Design/methodology/approach - This study proposes a new aggregate measure of the diversification discount. The authors’ measure allows for decomposition of the discount into firm-level mispricing, industry-level mispricing and long-run fundamental value components. Findings - Results support a catering theory of diversification. The discount appears to be the result of firm-level mispricing. Thus, providing an explanation for why, in light of the observed discount, a large number of diversified firms persist. Originality/value - To the authors’ knowledge, this is the first study to provide evidence that firm-level mispricing may drive the observed diversification discount.

Keywords: Corporate diversification; Catering theory; Corporate refocusing; Diversification discount; Investor preferences; Market mispricing (search for similar items in EconPapers)
Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:eme:rafpps:raf-11-2016-0172

DOI: 10.1108/RAF-11-2016-0172

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