Corporate Diversification, Relatedness, and Firm Value: Evidence from Korean Firms*

Abstract

We examine the valuation effects of diversification activities for Korean firms by diversification type and the occasion of the Korean financial crisis. Employing a unique dataset of 2,894 firm-years for the entire manufacturing industries, we find that diversification by Korean firms on average decreases firm value but its effect varies by the type of diversification. While unrelated diversification erodes firm value, related diversification is associated with a non-negative effect on firm value. These valuation effects are more pronounced before the crisis than after the crisis. Our results also show an important role of a firm's affiliation to a large business group, known as chaebols, that related diversification by chaebol-affiliated firms comes with a significant value gain. We further find that the different valuation effects of unrelated and related diversification are closely related to a firm's ownership concentration and financial leverage. Our results are robust to different samples and regression model specifications.

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

“…The evidence on the performance consequences of diversification in emerging markets is limited and inconclusive (e.g., Khanna and Palepu 2000;Lins and Servaes 2002;Fauver et al 2003;Bae et al 2008). Some studies document a positive valuation or performance effect of corporate diversification, supporting the argument that corporate diversification can be more valuable in emerging markets than in developed economies.…”

“…Moreover, they find the diversification discount to be at least partially related to the ability of controlling shareholders and managers to extract private benefits. Looking at a single country, South Korea, Bae et al (2008) find that corporate diversification on average decreases firm value, but the negative valuation effect stems mainly from unrelated, rather than related, diversification. They also find that related diversification by Korean firms suffer from a greater loss in value when the firms have a more concentrated ownership structure.…”

“…On the other hand, it enables firms' controlling shareholders to take advantage of their superior information and greater control power to pursue personal benefits at the expense of minority shareholders, resulting in lower firm value (Lins and Servaes 2002). Despite the prevalence of corporate diversification, prior research on this issue still provides limited and mixed evidence for emerging countries due to the complex nature of such corporate activities (Khanna and Palepu 2000;Lins and Servaes 2002;Fauver et al 2003;Bae et al 2008). Therefore, this study intends to add a well-known agency issue for emerging markets, entrenched controlling shareholders with excess board seats control, into the discussion of the value/ performance effects of diversification for a sample of Taiwanese firms.…”

Effect of Group Affiliation on Investments: Evidence from the Global Economic Crisis*

“…They interpret this result as reflecting the likelihood that business group structure could be effective in absorbing sudden economic crises. Bae et al. (2008) examine the valuation effects of diversification activities of Korean chaebols during the Asian financial crisis.…”

Performance Implications of Diversification Strategies During Institutional Transformations: An Emerging Market Study

“…Firms affiliated to large business groups are highly diversified and are well positioned to achieve superior performance by taking advantage of economies of scale and scope (Piskorski, 2005;Anand, 2005;Anand & Jayanthi, 2005). Their ability to internalize institutional voids in the economy by creating internal labor, product and capital markets provides them a competitive advantage (Bae, Kwon, & Lee, 2008). Also their scale enables them to gain proximity to regulators, which also helps them garner larger share of scarce economic resources, depriving the competition (Wan, 2005).…”