Corporate diversification: Can the observed diversification discount shed light on management’s choice to diversify or re-focus?
Review of Accounting and Finance
ISSN: 1475-7702
Article publication date: 2 August 2018
Issue publication date: 3 September 2018
Abstract
Purpose
The purpose of this study is to compare two theories that relate the proportion of diversified firms in the economy and the implied discount for diversified firms: the first is a real-options model predicting a positive relationship between the discount and management’s choice to operate a diversified firm; the second is based on catering theory, in which a negative relationship is predicted, as management is attentive to investor preference concerning diversified firms.
Design/methodology/approach
This study proposes a new aggregate measure of the diversification discount. The authors’ measure allows for decomposition of the discount into firm-level mispricing, industry-level mispricing and long-run fundamental value components.
Findings
Results support a catering theory of diversification. The discount appears to be the result of firm-level mispricing. Thus, providing an explanation for why, in light of the observed discount, a large number of diversified firms persist.
Originality/value
To the authors’ knowledge, this is the first study to provide evidence that firm-level mispricing may drive the observed diversification discount.
Keywords
Citation
Smith, G.C.C. and Coy, J.M. (2018), "Corporate diversification: Can the observed diversification discount shed light on management’s choice to diversify or re-focus?", Review of Accounting and Finance, Vol. 17 No. 3, pp. 405-424. https://doi.org/10.1108/RAF-11-2016-0172
Publisher
:Emerald Publishing Limited
Copyright © 2018, Emerald Publishing Limited