Why Focus Matters

Abstract

In this study, we trace the impact of corporate focus by estimating the relationships of focus with cash flow and firm value. In contrast to past studies that examine the effects of diversifying across SIC code defined industries, we show, using Tobin's q, that diversification even within a single industry negatively affects value. Our evidence indicates that this value reduction is not due to poor managerial performance. Project level cash flows are actually higher for less focused firms. However, these gains are exactly offset by higher management, administrative and interest expenses. Thus the corporate cash flows available to shareholders are not related to focus. Finally, we provide empirical evidence that links the effect of focus on value to informational asymmetries which cause the equity of diversified firms to be less liquid.

JEL Classification: G30