Diversification, Refocusing and Firm Value

Abstract

At any point in time a firm faces three restructuring choices: diversify, refocus, or do nothing. This study analyses the causes and the consequences of these actions in a unified framework using the appropriate methodologies. Various factors, such as firm's characteristics and multinational nature, its industry's characteristics, its exchange and index inclusion, and divested (or acquired) segment(s)' industry conditions, are considered as the determinants of the diversifying and the refocusing decisions. The estimation results from the corresponding multinomial logit model suggest that refocusing occurs generally due to firm-specific reasons, and diversification due to outside factors, such as industry and economic conditions. Added or dropped segment's industry profitability, its relationship to the core business of the firm, and its relatedness to the businesses of the conglomerate's other segments have a nontrivial effect on either decision. In a related analysis, the paper explicitly models and estimates the valuation consequences that are sustained by the firm after it undertakes a refocusing or a diversification action. To isolate the changes in firm's value that are due to these decisions only, a 2SLS estimation is used to control for endogeneity that arises because the factors that affect a firm's value are likely to have also induced the firm to make the corresponding decision. The novelty of my approach is in its inclusion of variables measuring the consequences due to both actions, the diversification and the refocusing, in the same valuation equation. Contrary to some earlier findings, I find no evidence of 'diversification discount' or 'refocusing premium.' The choice of this paper to analyse all corporate restructuring decisions in a unified framework yields valuable business insights into the reasons for undertaking such corporate events.

Do market predictions affect its reaction to UK listed industrial firms' corporate refocusing announcements?

“…These results are consistent with the hypotheses in Section 3.1 and with previous studies (i.e Gibbs 1993;. Berger and Ofek 1996;Denis and Kruse 2000;Haynes et al 2003;Colak and Whited 2006;Colak 2010).…”

“…A C C E P T E D ACCEPTED MANUSCRIPT Penman (2012) and Colak (2010) demonstrate that an increased number of firms undertake divestitures when economic conditions suffer a downturn (such as due to the bursting of the technology and internet bubbles in 2001 and afterwards). The effect of the economic recession is measured by a dummy related to the Gross Domestic Product in the twelve months prior to month t ‫ܲܦܩ(‬ ௧ି12 ).…”

“…A C C E P T E D ACCEPTED MANUSCRIPT 10 A deterioration in performance indicates inefficient management and increases the probability of managers announcing a refocusing plan (see Palepu, 1986;Markides, 1995;Berger and Ofek, 1999;Haynes et al, 2003;Powell and Yawson, 2005;Colak and Whited, 2006;Colak, 2010). Market performance is measured by the cumulative abnormal stock returns of firm i for the twelve months prior to month t (CAR12m ,௧ି12 ).…”

The link between product diversification and performance among Spanish manufacturing firms: Analyzing the role of firm size

“…There are studies reporting a positive and linear relationship between the level of PD and performance (e.g., Chang & Hong, 2002;Miller, 2006). There are also studies that find a negative and linear relationship (e.g., Braakmann & Wagner, 2011;Tongli, Ping, & Chiu, 2005), while others find no significant relationship (e.g., Çolak, 2010;Gort, 1962;Montgomery, 1985). Other studies have examined the difference between related and unrelated diversification (e.g., Christensen & Montgomery, 1981;Rumelt, 1974Rumelt, , 1982Tallman & Li, 1996).…”

Significance of Studying Product Diversification, Geographic Diversification, and Their Interaction Impacts for Malaysian Companies: A Literature Review

“…Next, concerning product diversification measurement, certain scholars (Pandya & Rao, 1998;Tan, Chang, & Lee, 2007) measured this strategy using Rumelt's (1974) diversification classes, while others depended on using continuous measures such as Diversification Entropy Measure (David, O'Brien, Yoshikawa, & Delios, 2010;Singh, Mathur, Gleason, & Etebari, 2001) or Herfindahl Index (Çolak, 2010;Fukui & Ushijima, 2006). The use of different measurement methodologies for geographic diversification such as foreign sales ratio (Capar & Kotabe, 2003;Geringer, Beamish, & daCosta, 1989), geographic entropy measure (Hitt et al, 1997), along with many others have also been frequently observed in the history of literature on the field.…”