45 Pages Posted: 10 Apr 2015 Last revised: 18 Jul 2017
Date Written: July 17, 2017
This paper examines how the effect of uncertainty on capital investment varies between focused firms and conglomerate segments. One of the advantages of conglomeration is that segments have access to the conglomerate's internal capital market and are thus less likely to be financially constrained. Consistent with the idea that uncertainty exacerbates financial frictions, I find that industry-level uncertainty has a negative effect on the investment of focused firms but has no statistically significant effect on the investment of conglomerate segments. An average conglomerate firm is likely to redeploy investment capital from the segments in low uncertainty industry to the segments in high uncertainty industry. Excess values and acquisition announcement returns of conglomerate firms are increasing in the industry-level uncertainty. Overall, this study highlights that corporate diversification may improve the efficiency of capital investment decisions under uncertainty.
Keywords: Uncertainty, capital investment, corporate diversification, internal capital markets, financial frictions
JEL Classification: G30, G32, G39
Suggested Citation: Suggested Citation