Apples to Apples: The Economic Benefit of Corporate Diversification

Abstract

Valuation differences between focused and diversified firms calculated in the conventional manner are misleading due to comparing smaller, younger, and more volatile focused firms with larger, older and less volatile diversified firms. The largest diversified firms are also the most valuable and as a consequence the value-weighted diversification “discount” is actually a premium. We highlight this issue by showing that diversified firms have a value-weighted average economy-wide gain of $644 billion annually relative to imputed firm values based on focused firms. Also diversified firms comprise 75% on average of the market value of the S&P 500, so among large firms, they are considered more valuable. We show that the diversification “discount” is an artifact of comparing focused and diversified firms that differ substantially on dimensions related to the uncertainty of their growth rates. After accounting for firm differences using both propensity score methods and coarsened exact matching, we show that diversified firms have higher or equal market values to similar focused firms. We construct a new excess value measure that controls directly for characteristics associated with growth rate uncertainty and show that under this measure there is no diversification discount.

Keywords: organizational structure, diversification, firm valuation, conglomerates, coarsened exact matching

JEL Classification: G32, G34