How Much of the Diversification Discount Can Be Explained by Poor Corporate Governance?

Abstract

We investigate whether the diversification discount is simply a proxy for poor corporate governance. We find that the negative value impact of diversification is amplified by adverse governance variables such as low CEO ownership, low board independence, and board classification, and that approximately 25% to 30% of the diversification discount can be attributed to suboptimal governance choices by conglomerate firms. Our methodology includes a dynamic panel GMM estimator that accounts for the endogeneity of the diversification decision and corporate governance, plus an event study analysis of diversifying mergers. Even after controlling for governance, the diversification discount remains negative and significant.