Why Agency Costs Explain Diversification Discounts
Posted: 21 May 2001
We study diversification within the real estate industry because of its relative transparency: portfolio management of assets with well-defined market prices. Diversification is over property types and geographical regions. The major cause of the diversification discount is not diversification per se but anticipated costs due to rent dissipation in future diversifying acquisitions. Firms expected to pursue non-focusing strategies do indeed diversify more; are valued ex ante at a 20% discount over firms anticipated to follow a focusing strategy; are predominantly privately controlled and extensively using dual-class shares. The ex ante diversification discount is therefore a measure of agency costs.
Keywords: Diversification, diversifying strategy, ex ante discounts, rent dissipation, agency costs, private control
JEL Classification: G30, G31, G32
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