Corporate Diversification and Agency

37 Pages Posted: 14 Feb 2000

See all articles by Benjamin E. Hermalin

Benjamin E. Hermalin

University of California, Berkeley

Michael L. Katz

University of California, Berkeley - Department of Economics; Haas School of Business

Date Written: January 10, 2000

Abstract

Firms undertake a variety of actions to reduce risk through diversification, including entering diverse lines of business, taking on project partners, and maintaining portfolios of risky projects such as R&D or natural resource exploration. By a well-known argument, securities holders do not directly benefit from risk-reducing corporate diversification when they can replicate this diversification on their own. Moreover, shareholders should be risk neutral with respect to the unsystematic risk that is associated with many research projects. Some have argued that corporate risk reduction may be of value, or can otherwise be explained by, the agency relationship between securities holders and managers. We argue that the value of diversification strategies in an agency relationship derives not from its effects on risk, but rather from its effects on the principal's information about the agent's actions. We demonstrate by example that diversification activities may increase or decrease the principal's information, depending on the particular structure of the activity.

JEL Classification: D21, D23, D81, D82, G34, L14, L21

Suggested Citation

Hermalin, Benjamin E. and Katz, Michael L., Corporate Diversification and Agency (January 10, 2000). Available at SSRN: https://ssrn.com/abstract=204619 or http://dx.doi.org/10.2139/ssrn.204619

Benjamin E. Hermalin (Contact Author)

University of California, Berkeley ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
510-642-7575 (Phone)
510-643-1420 (Fax)

Michael L. Katz

University of California, Berkeley - Department of Economics ( email )

579 Evans Hall
Berkeley, CA 94709
United States

Haas School of Business ( email )

Berkeley, CA 94720
United States

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