The Diversification Discount Puzzle: Evidence for a Transaction‐Cost Resolution

Raj Aggarwal and Shelly Zhao

The Financial Review, 2009, vol. 44, issue 1, 113-135

Abstract: The literature on the corporate diversification discount and the relative efficiency of internal versus external capital markets provides mixed results. We argue that transaction‐cost economics is useful in understanding this puzzle. According to transaction‐cost economics, diversified firms should outperform single segment firms in industries with higher external transaction costs (e.g., emergent industries) and under‐perform in industries with low external transaction costs and high agency and other internal costs (e.g., some mature industries). This paper provides evidence supporting these contentions.

Date: 2009
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