Discount or Premium? New Evidence on Corporate Diversification of UK Firms

Abstract

Contrary to previous findings stressing the agency problem of UK conglomerates, we provide evidence that corporate diversification in the UK is beneficial for shareholders. We show that previous results relying on the standard pooled OLS technique are bias caused by the endogenous diversification decision. The empirical results indicate that the diversification status is determined by firm characteristics, changes in mergers and acquisitions activities as well as macroeconomic developments. After controlling for the endogeneity of diversification in its effect on the market value, it turns out to be beneficial to diversify, increasing the firm value with about 30%. Moreover, while US studies with similar positive findings explain the lower market value of conglomerates relative to focused firms by firm-specific characteristics, we find for the UK conglomerates significant macroeconomic effects. In particular, less favorable macroeconomic conditions hinder firm's growth, decrease their market value and affect positively their decision to operate as a diversified firm.

Keywords: Corporate diversification, UK market, Endogenous diversification decision, Firm characteristics

JEL Classification: G34, G39, L2