Does global diversification destroy firm value?

Abstract

Previous empirical studies have found that global diversification results in 18% shareholder loss. In this paper, we examine the sources behind the global diversification shareholder value loss in a contingent claims framework. This postulates that the risk-reduction effects of global diversification should decrease the value of shareholder equity (call option), whereas they should increase bondholder value. Consequently, near-all equity globally diversified firms should not experience a shareholder value loss. Consistent with the risk-reduction effects of global diversification, using cross-border acquisitions data we find three major results. First, shareholder value loss to global diversification is directly related to firms' leverage. Second, near-all equity firms do not trade at a discount. Third, the use of book value debt in estimating excess value produces a downward bias in globally diversified firms. Our findings confirm that increased foreign involvement increases bondholder value while it decreases shareholder value. This is consistent with the contingent claims view predicting that global diversification has a positive impact on bondholders' wealth while it has a negative influence on shareholder value (i.e., global diversification discount). Overall, our results reveal that global diversification does not destroy firm value. Journal of International Business Studies (2006), 37, 352–371. doi:10.1057/palgrave.jibs.8400203

Reverse international knowledge transfer in the MNE: (Where) does affiliate performance boost parent performance?

“…The arguments for this date back to Cantwell (1999) and the theoretical analysis of Fosfuri and Motta (1999), who show that it can be profitable for technological laggards in a given sector to invest in the home country of more technologically advanced competitors because the potential learning effects are so strong. This also chimes with the more general literature on FDI and performance: for example, Doukas and Kan (2006) relate the sector of the investment in relation to the core technology of the parent, and show that FDI is more successful when firms engage in within-core sectors. There is also evidence that this is linked more generally to the management of technology or knowledge within the firm (Yang et al 2008).…”

Diversification as a Corporate Strategy and Its Effect on Firm Performance: A Study of Zimbabwean Listed Conglomerates in the Food and Beverages Sector

“…Villalonga (2004b) estimated the value effect of diversification by matching diversifying and single segment firms on their propensity score and found out that diversification does not destroy shareholder value. In the same direction Doukas and Kan (2006) pointed out that segments acquired by diversifying firms in most cases already traded at a discount before acquisition and hence their acquisition will improve performance, thus refuting the post acquisition negative relationship between diversification and performance in terms of profitability and shareholder value. Others have also shown that high levels of diversification are detrimental to profitability and on average destroy shareholder value for diversifiers pointing to the fact that refocusing generates positive shareholder returns.…”

“…Academics, consultants, the public and financial community have different views. Some studies such as (Villalonga, 2004a(Villalonga, , 2004bDos Santos, 2008;Doukas & Kan, 2006;Santalo & Becerra, 2008) have been aimed at establishing whether diversification leads to shareholder value destruction or improvement that is, either creating a discount or a premium. Some studies have proved that high levels of diversification increase profitability and shareholder value (Dimitrov & Tice, 2006;Yan et al, 2010;Kuppuswamy & Villalonga, 2010).…”

“…The evidence that supports this conclusion comes from a variety of sources. Diversified firms tend to have a lower Tobin's Q; they trade at a discount of up to 15%, when compared to the value of a portfolio of stand-alone firms; they face an increased likelihood of being broken up through reorganization that varies directly with the size of the discount; and the stock market tends to react favourably to increases in refocus (Collins & Montgomery, 2008;Masulis et al, 2007;Doukas & Kan 2006;Stulz et al, 2007). In line with this school of thought Breadley et al argue that companies should stick to their core competencies and let shareholders diversify on their own as diversification is costly rather than beneficial for the corporation.…”

“…The author states that poor multidivisional performance destroys value. Doukas and Kan (2006), point out the problem of capital misallocation in diversified firms as the one of the reasons for poor performance.…”