Does global diversification destroy firm value?

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.

[1]  Kathleen M. Kahle,et al.  The Impact of Industry Classifications on Financial Research , 1996, Journal of Financial and Quantitative Analysis.

[2]  D. Reeb,et al.  Corporate Diversification: What Gets Discounted? , 2002 .

[3]  J. Campa,et al.  Shareholder Value Creation in European M&As , 2004 .

[4]  Owen A. Lamont.  Cash Flow and Investment: Evidence from Internal Capital Markets , 1996 .

[5]  J. Graham,et al.  Does Corporate Diversification Destroy Value? , 2001 .

[6]  Henri Servaes,et al.  The Value of Diversification During the Conglomerate Merger Wave , 1996 .

[7]  Lemma W. Senbet,et al.  International Corporate Diversification, Market Valuation, and Size-Adjusted Evidence , 1984 .

[8]  John A. Doukas.  Overinvestment, Tobin's q and gains from foreign acquisitions , 1995 .

[9]  John A. Doukas,et al.  Intangible Assets and the Network Structure of MNCs , 1999 .

[10]  Philippe Jorion,et al.  The Exchange-Rate Exposure of U.S. Multinationals , 1990 .

[11]  Larry H. P. Lang,et al.  Foreign direct investment, diversification and firm performance , 2003 .

[12]  R. Caves.  International Corporations: The Industrial Economics of Foreign Investment , 1971 .

[13]  Paul Harrison,et al.  Does Multinationality Matter? Evidence of Value Destruction in U.S. Multinational Corporations , 2000 .

[14]  J. Papastavrou,et al.  Accounting for Endogeneity When Assessing Strategy Performance: Does Entry Mode Choice Affect Fdi Survival , 1998 .

[15]  Simi Kedia,et al.  Explaining the Diversification Discount , 1999 .

[16]  D. Scharfstein.  The Dark Side of Internal Capital Markets Ii: Evidence from Diversified Conglomerates , 1998 .

[17]  B. Eckbo,et al.  Gains to Bidder Firms Revisited: Domestic and Foreign Acquisitions in Canada , 1999, Journal of Financial and Quantitative Analysis.

[18]  John H. Dunning,et al.  The Determinants of International Production , 1973 .

[19]  Bernard Yeung,et al.  Why Firms Diversify: Internalization vs. Agency Behavior , 1998 .

[20]  David J. Denis,et al.  Global Diversification, Industrial Diversification, and Firm Value , 2001 .

[21]  J. Heckman.  Sample selection bias as a specification error , 1979 .

[22]  Ali Fatemi.  Shareholder Benefits from Corporate International Diversification , 1984 .

[23]  M. C. Jensen,et al.  Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers , 1999 .

[24]  Lemma W. Senbet,et al.  The Effects of International Operations on the Market Value of the Firm: Theory and Evidence , 1981 .

[25]  Gordon M. Bodnar,et al.  Both Sides of Corporate Diversification: The Value Impacts of Geographic and Industrial Diversification , 1997 .

[26]  Sara B. Moeller,et al.  Global diversification and bidder gains: A comparison between cross-border and domestic acquisitions , 2005 .

[27]  John A. Doukas,et al.  The Effect of Corporate Multinationalism on Shareholders' Wealth: Evidence from International Acquisitions , 1988 .

[28]  Stephen E. Christophe.  Hysteresis and the Value of the U.S. Multinational Corporation , 1997 .

[29]  E. Ofek,et al.  Diversification's effect on firm value , 1995 .

[30]  Bernard Yeung,et al.  Why Investors Value Multinationality , 1993 .

[31]  Christopher Polk,et al.  Does diversification destroy value? Evidence from the industry shocks , 2002 .

[32]  René M. Stulz,et al.  On the Effects of Barriers to International Investment , 1981 .

[33]  Y. Amihud,et al.  Risk Reduction as a Managerial Motive for Conglomerate Mergers , 1981 .

[34]  M. C. Jensen,et al.  Harvard Business School; SSRN; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Harvard University - Accounting & Control Unit , 1976 .

[35]  René M. Stulz,et al.  Tobin's q, Corporate Diversification, and Firm Performance , 1993, Journal of Political Economy.

[36]  E. Ofek,et al.  Bustup Takeover of Value-Destroying Diversified Firms , 1994 .