Product Demand Sensitivity and the Corporate Diversification Discount

64 Pages Posted: 2 Oct 2019 Last revised: 26 May 2020

See all articles by M. Kabir Hassan

M. Kabir Hassan

University of New Orleans - College of Business Administration - Department of Economics and Finance

Neal Maroney

University of New Orleans - College of Business Administration

Ibrahim Siraj

Long Island University-Post

Date Written: May 5, 2020

Abstract

We consider consumer responsiveness to changes in the macroeconomic environment (i.e. product demand sensitivity) to be a systematic industry characteristic useful to studying how industrial diversification adds value. We argue that diversified firms, with the advantages of their internal capital market and the imperfectly correlated cash flows of their segments, will perform better than focused firms when the demand sensitivity of a product increases. Our empirical evidence reveals a significant diversification premium associated with an increase in sensitivity. Moreover, such premium predominantly exists during recessionary periods, disappearing in the presence of low coinsurance and inefficient use of the internal capital market. Our results are robust to alternative measures of sensitivity and performance metrics, different empirical model specifications, and to the concern of possibly biased estimations associated with the sample of diversified and focused firms.

Keywords: Corporate Diversification Discount; Organizational Structure; Firm Valuation; Industrial Structure; Demand Sensitivity

JEL Classification: G32; G34; L16

Suggested Citation

Hassan, M. Kabir and Maroney, Neal and Siraj, Ibrahim, Product Demand Sensitivity and the Corporate Diversification Discount (May 5, 2020). Journal of Financial Stability, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3450177 or http://dx.doi.org/10.2139/ssrn.3450177

M. Kabir Hassan

University of New Orleans - College of Business Administration - Department of Economics and Finance ( email )

2000 Lakeshore Drive
New Orleans, LA 70148
United States

Neal Maroney

University of New Orleans - College of Business Administration ( email )

2000 Lakeshore Drive
New Orleans, LA 70148
United States

Ibrahim Siraj (Contact Author)

Long Island University-Post ( email )

United States

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