The commonly accepted explanation in early studies to diversification discount is that diversification destroys value because of operational inefficiency. Such argument neglects the value of growth potentials incorporated in the value measures such as market-to-book ratio. Our study indicates that diversification activities are strategic decisions that will change the real options of a firm and will create value impacts that are different from those caused by changes in operational efficiency. We find that diversification activities, especially unrelated diversification activities, carried out by below average performers tend to increase firm value, in terms of market-to-book ratio, as a result of exploring for new growth opportunities. Whereas diversification activities carried out by above average performers tend to decrease firm value as a result of materializing excess capability. The result indicates that value changes around diversification are different for different firms. In addition to changes in operational efficiency, changes in growth potentials play a role in explaining diversification discount phenomenon as well.
Review of Quantitative Finance and Accounting – Springer Journals
Published: Jan 31, 2014
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