Corporate Diversification and Capital Structure
58 Pages Posted: 15 Nov 2019
Date Written: October 1, 2019
We examine how corporate diversification affects financial leverage. Our results suggest economically large financing advantages of diversified firms, which allow them to borrow more than comparable focused firms. We identify causal effects in a novel shock-based difference-in-differences research design using the introduction of new segment reporting standards (SFAS No. 131) as a quasi-natural experiment. SFAS 131 forced some firms to reveal previously hidden information about their level of firm diversification to outsiders, allowing us to exploit plausibly exogenous variation in a firm's observed diversification status. Firms that newly reveal information about their diversification strategies substantially increase leverage after the introduction of the new standard. We use standalone firms whose segment disclosures were unaffected by SFAS 131 as a counterfactual. Our findings identify cash flow coinsurance as the main channel of the effect. Agency problems at the divisional level can offset the positive effect of the coinsurance channel.
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