A Trade-Off in Corporate Diversification

52 Pages Posted: 6 Aug 2015 Last revised: 17 Aug 2015

See all articles by Manapol Ekkayokkaya

Manapol Ekkayokkaya

Chulalongkorn University - Department of Banking & Finance

Krishna Paudyal

University of Strathclyde

Date Written: July 19, 2015

Abstract

The marginal benefits of diversification exceed the costs by a decreasing margin, and diversifying beyond the optimal level will produce a wealth loss. This trade-off predicts an inverted U-relation between the degree of diversification and wealth. We find empirical evidence in support of this trade-off proposition. Consistent with the trade-off, firms diversify cautiously and stop diversifying before the marginal benefits are offset by the costs. Our findings lend support to the arguments suggesting efficient diversification. In line with the endogeneity of diversification, the findings also indicate that the optimal level of diversification can vary across firms depending on their reasons for diversifying.

Keywords: Corporate diversification, benefits and costs of diversification, non-linear wealth effect, acquisitions

JEL Classification: G31, G32, G34

Suggested Citation

Ekkayokkaya, Manapol and Paudyal, Krishna, A Trade-Off in Corporate Diversification (July 19, 2015). Journal of Empirical Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2640553 or http://dx.doi.org/10.2139/ssrn.2640553

Manapol Ekkayokkaya (Contact Author)

Chulalongkorn University - Department of Banking & Finance ( email )

Thailand

Krishna Paudyal

University of Strathclyde ( email )

Curran Building
100 Cathedral Street
Glasgow, G4 0LN
United Kingdom

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