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The Cost of Diversity: The Diversification Discount and Inefficient Investment

79 Pages Posted: 5 Feb 1998  

Raghuram G. Rajan

University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Henri Servaes

London Business School; Centre for Economic Policy Research (CEPR)

Luigi Zingales

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: May 1999

Abstract

In a simple model of capital budgeting in a diversified firm where headquarters has limited power, we show that funds are allocated towards the most inefficient divisions The distortion is greater the more diverse are the investment opportunities of the firm's divisions. We test these implications on a panel of diversified firms in the U.S. during the period 1979-1993. We find that i) diversified firms mis-allocate investment funds; ii) the extent of mis-allocation is positively related to the diversity of the investment opportunities across divisions; iii) the discount at which these diversified firms trade is positively related to the extent of the investment mis-allocation and to the diversity of the investment opportunities across divisions.

JEL Classification: G31, L22

Suggested Citation

Rajan, Raghuram G. and Servaes, Henri and Zingales, Luigi, The Cost of Diversity: The Diversification Discount and Inefficient Investment (May 1999). CRSP Working Paper No. 463. Available at SSRN: https://ssrn.com/abstract=56108 or http://dx.doi.org/10.2139/ssrn.56108

Raghuram Rajan (Contact Author)

University of Chicago - Booth School of Business ( email )

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International Monetary Fund (IMF) ( email )

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National Bureau of Economic Research (NBER)

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Henri Servaes

London Business School ( email )

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HOME PAGE: http://faculty.london.edu/hservaes/

Centre for Economic Policy Research (CEPR)

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United Kingdom

Luigi Zingales

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-3196 (Phone)
773-834-2081 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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