Debt, Diversification, and Valuation

Abstract

The separate associations between financial leverage and valuation and between diversification and valuation have been widely researched. The joint function of leverage, diversification, and valuation, however, has received much less attention. Previous research shows that compared to specialized firms, diversified firms tend to have higher free cash flows and fewer high net present value investment opportunities. Consequently, the agency costs associated with potential overinvestment are greater for diversified firms. The literature also proposes that financial leverage should reduce agency costs. Consequently, we expect that the values of diversified firms increase with leverage. Our tests provide strong support for the hypothesis that the values of diversified firms increase with leverage. This tendency is not observed for specialized firms. Copyright Springer Science + Business Media, Inc. 2005debt, leverage, diversification, valuation,

Firm diversification and earnings management: evidence from seasoned equity offerings

“…The first is a dummy variable, DSEG, equals one if the firm has operations in multiple segments, and zero if the firm has operations in a single segment (Ruland and Zhou 2005). The second measure for firm diversification is the number of business segments (NSEG) in an issuing firm.…”

The influence of growth opportunities on the relationship between equity ownership and leverage

“…Another strain looks at dividend change announcements in determining whether the dividend change provides information about changes in the managerial misuse of free cash flow (Lang and Litzenberger 1989;Yoon and Starks 1995). Further, a recent study by Ruland and Zhou (2005) argues that the agency costs associated with potential over-investment are greater for diversified firms than for specialized firms, and shows that the values of diversified firms increase with financial leverage. In an international context, Kang and Kim (2006) examine whether debt effectively curbs the private benefits of control for Korean firms, and suggest that the Asian financial crisis actuates the disciplinary role of debt.…”

Residual income, value-relevant information and equity valuation: a simultaneous equations approach

“…Agency theory suggests that the relationship of leverage and valuation is strong for diversified firms. Ruland and Zhou (2005) find that the values of diversified firms increase with leverage. Lam and Chng (2006) find that consistent with predictions of agency theory, executive stock option grants have value implications for the firm performance.…”