The Cost of Diversity: The Diversification Discount and Inefficient Investment

Raghuram Rajan, Henri Servaes and Luigi Zingales

No 1801, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In a simple model of capital budgeting in a diversified firm where headquarters have limited power, we show that funds are allocated towards the most inefficient divisions. The distortion is greater, when the investment oppotunities of the firm’s divisions are more diverse. We test these implications on a panel of diversified firms in the United States during the period 1979–93. We find that i) diversified firms mis-allocate investment funds; ii) the extent of mis-allocation is positively related to the diversity of investment opportunities across divisions; and iii) the discount, at which these diversified firms trade, is positively related to the extent of the investment mis-allocation and to the diversity of investment opportunities across divisions.

Keywords: capital budgeting; conglomerate; Diversification (search for similar items in EconPapers)
JEL-codes: G31 L22 (search for similar items in EconPapers)
Date: 1998-03
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Citations: View citations in EconPapers (80)

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Related works:
Journal Article: The Cost of Diversity: The Diversification Discount and Inefficient Investment (2000)
Working Paper: The Cost of Diversity: The Diversification Discount and Inefficient Investment (1998)
Working Paper: The Cost of Diversity: The Diversification Discount and Inefficient Investment
Working Paper: The Cost of Diversity: The Diversification Discount and Inefficient Investment
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