Corporate Governance and Firm Diversification

39 Pages Posted: 3 Sep 1998  

Ronald C. Anderson

American University - Kogod School of Business

John M. Bizjak

Texas Christian University

Michael L. Lemmon

University of Utah - Department of Finance

Thomas W. Bates

Arizona State University - Department of Finance

Date Written: August 23, 1998

Abstract

We empirically investigate the relationship between corporate governance structure and diversification. Using a sample of 199 firms beginning in 1985 and following these firms through 1994, we examine 1) if governance structure is significantly different between focused and diversified firms; 2) if differences in corporate governance are associated with the decision to become more focused or diverse; and 3) if the previously documented value loss from diversification is associated with governance structure. We find that, relative to focused firms, diversified firms exhibit higher levels of pay and lower sensitivity of pay to firm performance, have more outsiders on the board, have similar sensitivity of CEO turnover to performance, and no economic difference in independent blockholdings. We find that firms that increase their level of diversification over the sample period have governance and performance characteristics remarkably similar to firms that retain their focus. Firms that decrease their level of diversification, however, have lower insider ownership but more equity-based compensation relative to focused firms. We find no evidence that governance characteristics explain the value loss associated with diversification. We do find, however, that the fraction of outside directors in a diversified firm is positively related to firm value. Collectively, our results suggest that diversified firms use alternative governance mechanisms as substitutes for low pay-for-performance sensitivity and CEO ownership. We conclude that agency costs do not provide a complete explanation for the magnitude and persistence of the diversification discount.

JEL Classification: G30, G34

Suggested Citation

Anderson, Ronald C. and Bizjak , John M. and Lemmon, Michael L. and Bates, Thomas W., Corporate Governance and Firm Diversification (August 23, 1998). Available at SSRN: https://ssrn.com/abstract=121013 or http://dx.doi.org/10.2139/ssrn.121013

Ronald Craig Anderson

American University - Kogod School of Business ( email )

4400 Massachusetts Avenue NW
Washington, DC 20816-8044
United States
202-885-2199 (Phone)
202-885-1946 (Fax)

John M. Bizjak (Contact Author)

Texas Christian University ( email )

Fort Worth, TX 76129
United States
817-257-4260 (Phone)

Michael L. Lemmon

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States
801-585-5210 (Phone)
801-581-7214 (Fax)

Thomas W. Bates

Arizona State University - Department of Finance ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

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