Essays on Corporate Diversification

Abstract

This thesis consists of three empirical essays on corporate diversification. The first empirical study (Chapter 2) examines the relationship between coinsurance across divisional investment opportunities and the value of corporate cash holdings. The study finds that coinsurance across divisional investment opportunities reduces the value of cash for poorly governed firms and constrained firms, but increases the value of cash for firms with efficient internal capital markets. Evidence suggests that the agency channel dominates the other two, leading to an overall negative effect of coinsurance across divisional investment opportunities on the marginal value of cash. The second empirical study (Chapter 3) examines the impact of coinsurance across divisional investment opportunities on merger outcomes. The study finds that coinsurance across divisional investment opportunities is negatively associated with acquirer announcement returns and post-merger operating performance. The study documents a positive link between coinsurance across divisional investment opportunities and the probability of firms initiating mergers when they are poorly-governed. Evidence suggests that coinsurance across divisional investment opportunities is closely associated with agency problems and thus can lead to value destruction in diversified firms. The third empirical study (Chapter 4) examines the impact of product market competition on the relationship between corporate diversification and the cost of debt financing. The study finds that that product market competition amplifies the cost-reduction benefits of diversification for financially constrained firms and firms with efficient internal capital markets, but it can reduce the diversification benefits for firms with a high level of multimarket contacts. Although intense competition may, in some cases, undermine the tacit collusion through the multimarket contacts in diversified firms, overall, the negative association between diversification and cost of debt financing is stronger in firms facing intense competition. Evidence suggests that the diversification benefits in the debt market, to some extent, alleviate the negative effect of diversification in the equity market.