The Dynamics of Diversification Discount*

Abstract

Using a sample of diversified firms over the period of 1980-2003, I investigate changes in the diversification discount over the two decades. The time-series pattern of the diversification discount is created by the entrance and exit of discount firms. I find that the distribution of excess value can correctly predict the survivalship of a diversified firm. Discount firms are more likely to reverse their diversification within short time period. By contrast, the survival of diversification strategies among premium firms and focused firms is unrelated to the firms' excess values. After accounting for value effects, premium firms perform better than focused firms and discount firms. I interpret the results as evidence that excess value can correctly identify these firms that are successful and unsuccessful in their diversification.

Corporate diversification

“…Basu (2010) reports trends in corporate diversification, as well as a common strategic motivation among diversified firms that re-focus, showing that approximately 33 per cent of diversifying firms re-focus to single segment firms within four years. Related, Ahn (2009) calculates the annual average diversification discount, as well as the number of diversified firms within the economy and reports that firms with deep discounts typically re-focus within four years.…”

Managerial incentives for risk-taking and internal capital allocation

“…We also eliminate segments with zero depreciation, capital expenditures greater than sales, negative capital expenditures, and negative assets. Firms sometimes report segments which do not have actual economic activities titled as, for example, “corporate adjustment,” “intersegment elimination,” and “reconciling items.” Because the accounting data in these segments represent unallocated amount in sales, assets, and operating profits, we also remove these non-economic segments from our sample (Ahn, 2010). Finally, we exclude firms with sales less than US$20 million.…”

Corporate Diversification and Managerial Overconfidence

“…In that respect, lagged excess value can be used as an instrument that encapsulates information from unobserved characteristics that relate to profiles and impact firms' values. The use of lagged excess value is further motivated by the findings of Ahn (2009), who reports that excess value has predictive power on the survival of the diversification strategy (i.e., excess value is negatively related to the probability of refocusing operations).…”