Corporate Diversification and Agency

Benjamin Hermalin and Michael Katz (mlkatz@berkeley.edu)

Research Program in Finance, Working Paper Series from Research Program in Finance, Institute for Business and Economic Research, UC Berkeley

Abstract: Firms undertake a variety of actions to reduce risk through diversification, including entering diverse lines of business, taking on project partners, and maintaining portfolios of risky projects such as R&D or natural resource exploration. By a well-known argument, securities holders do not directly benefit from risk-reducing corporate diversification when they can replicate this diversification on their own. Moreover, shareholders should be risk neutral with respect to the unsystematic risk that is associated with many research projects. Some have argued that corporate risk reduction may be of value, or can otherwise be explained by, the agency relationship between securities holders and managers. We argue that the value of diversification strategies in an agency relationship derives not from its effects on risk, but rather from its effects on the principal's information about the agent's actions. We demonstrate by example that diversification activities may increase or decrease the principal's information, depending on the particular structure of the activity

Keywords: diversification; principal-agent relationship (search for similar items in EconPapers)
Date: 2000-01-02
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Citations: View citations in EconPapers (4)

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Related works:
Working Paper: Corporate Diversification and Agency (2000)
Working Paper: Corporate Diversification and Agency (2000)
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