Firm Complexity: The ‘Dark Side’ of Geographic Diversification
45 Pages Posted: 4 Oct 2017 Last revised: 23 Jul 2019
Date Written: July 22, 2019
In this paper we analyze the effects of geographic diversification on firm risk using a new dataset containing granular information on firm geographic locations. After accounting for determinants of geographic diversification, we find that geographically complex firms are characterized by significantly higher risk, reflected in lower credit quality, than their locally focused peers. The findings are consistent with geographically complex firms having higher information and monitoring costs. The higher risk of geographically diversified firms is not consistent with the hedging hypothesis that predicts a reduction in risk as a result of geographic diversification of cash flows and business risk. The identified effects are economically important and are more pronounced in the presence of business diversification. The results hold for firms of varying size and cannot be explained by business diversification or other firm, industry, and local factors.
Keywords: firm complexity, geographic diversification, information frictions, location, credit quality
JEL Classification: G30, G32, G34
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