The Hedging Benefits of Domestic and Global Diversification: Evidence from Economic Downturns

68 Pages Posted: 22 Feb 2016

See all articles by Yixin Liu

Yixin Liu

University of New Hampshire

David C. Mauer

University of North Carolina (UNC) at Charlotte

Yilei Zhang

University of North Carolina (UNC) at Charlotte

Date Written: February 21, 2016

Abstract

We examine the influence of economic downturns on the relation between diversification and firm value in a large panel of U.S. firms over the period from 1984 to 2014. When markets are incomplete or there are significant frictions, diversification provides value when the fortunes of one business segment are imperfectly correlated with the fortunes of another. We test whether this hedging effect of diversification is valued by the market. We find that the hedging value of diversification during economic downturns reduces the diversification discount by 9% for domestically diversified firms and 12% for globally diversified firms. Our results are robust to controlling for endogeneity of diversification decisions. Consistent with a hedging value of diversification, we find that risk reduction as measured by the correlation of a firm’s industrial and regional operations with the state of the economy is a key channel through which diversification becomes more valuable during economic downturns. We find little evidence that the enhanced value of diversification during downturns is attributable to alternative explanations such as mitigation of overinvestment in value-reducing diversification strategies, enhanced value of internal capital markets, or more valuable debt coinsurance.

Keywords: Diversification, Globalization, Hedging, Firm valuation

JEL Classification: F23, G31, G32, G34

Suggested Citation

Liu, Yixin and Mauer, David C. and Zhang, Yilei, The Hedging Benefits of Domestic and Global Diversification: Evidence from Economic Downturns (February 21, 2016). Available at SSRN: https://ssrn.com/abstract=2735922 or http://dx.doi.org/10.2139/ssrn.2735922

Yixin Liu

University of New Hampshire ( email )

Durham, NH 03824
United States
603-862-3357 (Phone)

David C. Mauer (Contact Author)

University of North Carolina (UNC) at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States
704-687-7707 (Phone)

Yilei Zhang

University of North Carolina (UNC) at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

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