Hostname: page-component-78c5997874-mlc7c Total loading time: 0 Render date: 2024-11-15T04:46:28.307Z Has data issue: false hasContentIssue false
  • English
  • Français

Why Do Firms with Diversification Discounts Have Higher Expected Returns?

Published online by Cambridge University Press:  17 September 2010

Todd Mitton  and
Keith Vorkink
Todd Mitton
Affiliation:
Marriott School, Brigham Young University, Provo, UT 84602. todd.mitton@byu.edu
Keith Vorkink
Affiliation:
Marriott School, Brigham Young University, Provo, UT 84602. keith_vorkink@byu.edu
Get access Rights & Permissions [Opens in a new window]

Abstract

A diversified firm can trade at a discount to a matched portfolio of single-segment firms if the diversified firm has either lower expected cash flows or higher expected returns than the single-segment firms. We study whether firms with diversification discounts have higher expected returns in order to compensate investors for offering less upside potential (or skewness exposure) than focused firms. Our empirical tests support this hypothesis. First, we find that focused firms offer greater skewness exposure than diversified firms. Second, we find that diversified firms have significantly larger discounts when the diversified firm offers less skewness than matched single-segment firms. Finally, we find that up to 53% of the excess returns received on diversification-discount firms relative to diversification-premium firms can be explained by differences in exposure to skewness.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 6 , December 2010 , pp. 1367 - 1390
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Arditti, F. D. “Risk and the Required Return on Equity.” Journal of Finance, 22 (1967), 19–36.CrossRefGoogle Scholar
Barberis, N., and Huang, M.. “Stocks as Lotteries: The Implications of Probability Weighting for Security Prices.” American Economic Review, 98 (2008), 2066–2100.Google Scholar
Berger, P. G., and Ofek, E.. “Diversification’s Effect on Firm Value.” Journal of Financial Economics, 37 (1995), 39–65.CrossRefGoogle Scholar
Boyer, B.; Mitton, T.; and Vorkink, K.. “Expected Idiosyncratic Skewness.” Review of Financial Studies, 23 (2010), 169–202.Google Scholar
Brunnermeier, M. K., and Parker, J. A.. “Optimal Expectations.” American Economic Review, 95 (2005), 1092–1118.CrossRefGoogle Scholar
Campa, J. M., and Kedia, S.. “Explaining the Diversification Discount.” Journal of Finance, 57 (2002), 1731–1762.Google Scholar
Chen, J.; Hong, H.; and Stein, J. C.. “Forecasting Crashes: Trading Volume, Past Returns, and Conditional Skewness in Stock Prices.” Journal of Financial Economics, 61 (2001), 345–381.CrossRefGoogle Scholar
Chevalier, J. “What Do We Know About Cross-Subsidization? Evidence from Merging Firms.” Advances in Economic Analysis & Policy, 4 (2004), 1–27.CrossRefGoogle Scholar
Conine, T. E. Jr., and Tamarkin, M. J.. “On Diversification Given Asymmetry in Returns.” Journal of Finance, 36 (1981), 1143–1155.CrossRefGoogle Scholar
Conrad, J.; Dittmar, R.; and Ghysels, E.. “Skewness and the Bubble.” Working Paper, University of North Carolina (2008).Google Scholar
Denis, D. J.; Denis, D. K.; and Sarin, A.. “Agency Problems, Equity Ownership, and Corporate Diversification.” Journal of Finance, 52 (1997), 135–160.CrossRefGoogle Scholar
Diether, K. B.; Malloy, C. J.; and Scherbina, A.. “Differences of Opinion and the Cross Section of Stock Returns.” Journal of Finance, 57 (2002), 2113–2141.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Gertner, R. H.; Scharfstein, D. S.; and Stein, J. C.. “Internal versus External Capital Markets.” Quarterly Journal of Economics, 109 (1994), 1211–1230.Google Scholar
Gilson, S. C.; Healy, P. M.; Noe, C. F.; and Palepu, K. G.. “Analyst Specialization and Conglomerate Stock Breakups.” Journal of Accounting Research, 39 (2001), 565–582.CrossRefGoogle Scholar
Graham, J. R.; Lemmon, M. L.; and Wolf, J. G.. “Does Corporate Diversification Destroy Value?” Journal of Finance, 57 (2002), 695–720.CrossRefGoogle Scholar
Hadlock, C. J.; Ryngaert, M.; and Thomas, S.. “Corporate Structure and Equity Offerings: Are There Benefits to Diversification?” Journal of Business, 74 (2001), 613–635.CrossRefGoogle Scholar
Harvey, C. R., and Siddique, A.. “Conditional Skewness in Asset Pricing Tests.” Journal of Finance, 55 (2000), 1263–1295.CrossRefGoogle Scholar
Huberman, G.; Kandel, S.; and Stambaugh, R. F.. “Mimicking Portfolios and Exact Arbitrage Pricing.” Journal of Finance, 42 (1987), 1–9.CrossRefGoogle Scholar
Kraus, A., and Litzenberger, R. H.. “Skewness Preference and the Valuation of Risky Assets.” Journal of Finance, 31 (1976), 1085–1100.Google Scholar
Krishnaswami, S., and Subramaniam, V.. “Information Asymmetry, Valuation, and the Corporate Spin-Off Decision.” Journal of Financial Economics, 53 (1999), 73–112.CrossRefGoogle Scholar
Lamont, O. “Cash Flow and Investment: Evidence from Internal Capital Markets.” Journal of Finance, 52 (1997), 83–109.CrossRefGoogle Scholar
Lamont, O. A., and Polk, C.. “The Diversification Discount: Cash Flows versus Returns.” Journal of Finance, 56 (2001), 1693–1721.CrossRefGoogle Scholar
Lang, L. H. P., and Stulz, R. M.. “Tobin’s q, Corporate Diversification, and Firm Performance.” Journal of Political Economy, 102 (1994), 1248–1280.Google Scholar
Lewellen, W. G. “A Pure Financial Rationale for the Conglomerate Merger.” Journal of Finance, 26 (1971), 527–537.CrossRefGoogle Scholar
Lins, K., and Servaes, H.. “International Evidence on the Value of Corporate Diversification.” Journal of Finance, 54 (1999), 2215–2239.CrossRefGoogle Scholar
Maksimovic, V., and Phillips, G.. “Do Conglomerate Firms Allocate Resources Inefficiently across Industries? Theory and Evidence.” Journal of Finance, 57 (2002), 721–767.Google Scholar
Mansi, S. A., and Reeb, D. M.. “Corporate Diversification: What Gets Discounted?” Journal of Finance, 57 (2002), 2167–2183.CrossRefGoogle Scholar
Mitton, T., and Vorkink, K.. “Equilibrium Underdiversification and the Preference for Skewness.” Review of Financial Studies, 20 (2007), 1255–1288.CrossRefGoogle Scholar
Morck, R.; Shleifer, A.; and Vishny, R. W.. “Do Managerial Objectives Drive Bad Acquisitions?” Journal of Finance, 45 (1990), 31–48.CrossRefGoogle Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.CrossRefGoogle Scholar
Rajan, R.; Servaes, H.; and Zingales, L.. “The Cost of Diversity: The Diversification Discount and Inefficient Investment.” Journal of Finance, 55 (2000), 35–80.CrossRefGoogle Scholar
Scharfstein, D. S., and Stein, J. C.. “The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment.” Journal of Finance, 55 (2000), 2537–2564.Google Scholar
Schoar, A. “Effects of Corporate Diversification on Productivity.” Journal of Finance, 57 (2002), 2379–2403.Google Scholar
Scott, R. C., and Horvath, P. A.. “On the Direction of Preference for Moments of Higher Order Than the Variance.” Journal of Finance, 35 (1980), 915–919.CrossRefGoogle Scholar
Servaes, H. “The Value of Diversification During the Conglomerate Merger Wave.” Journal of Finance, 51 (1996), 1201–1225.CrossRefGoogle Scholar
Shin, H.-H., and Stulz, R. M.. “Are Internal Capital Markets Efficient?” Quarterly Journal of Economics, 113 (1998), 531–552.CrossRefGoogle Scholar
Simkowitz, M. A., and Beedles, W. L.. “Diversification in a Three-Moment World.” Journal of Financial and Quantitative Analysis, 13 (1978), 927–941.Google Scholar
Stein, J. C. “Internal Capital Markets and the Competition for Corporate Resources.” Journal of Finance, 52 (1997), 111–133.CrossRefGoogle Scholar
Tirole, J. The Theory of Industrial Organization. Cambridge, MA: MIT Press (1995).Google Scholar
Villalonga, B. “Diversification Discount or Premium? New Evidence from the Business Information Tracking Series.” Journal of Finance, 59 (2004a), 479–506.CrossRefGoogle Scholar
Villalonga, B. “Does Diversification Cause the ‘Diversification Discount’?” Financial Management, 33 (2004b), 5–27.Google Scholar
Whited, T. M. “Is It Inefficient Investment That Causes the Diversification Discount?” Journal of Finance, 56 (2001), 1667–1691.CrossRefGoogle Scholar