This study uses theoretical considerations to empirically examine the effects of various diversification strategies on the capital structure of firms and on the systematic risk. It documents that firms reduce their operating risk by diversification and increase financial leverage to take advantage of tax benefits. A cross-sectional path analysis is employed to show that firms trade off the reduction in operating risk due to diversification with increased financial leverage, and thus the systematic risk remains the same.
Get full access to this article
View all access options for this article.
References
1.
AmihudYakovLevB., “Risk Reduction As a Managerial Motive for Conglomerate Mergers,”Bell Journal of Economics, 12, no. 2 (1981), pp. 605–617.
2.
AmitR.LivnatJ., “Diversification and the Risk-Return Tradeoff,”Academy of Management Journal, 31, no. 1 (1988a).
3.
AmitR.LivnatJ., “Diversification Strategies: Business Cycles and Economic Performance,”Strategic Management Journal, 9, no. 2 (1988b).
4.
ArnouldR. J., “Conglomerate Growth and Public Policy”. In GordonL. (ed.), Economics of Conglomerate Growth (Corvallis: Oregon State University Department of Agricultural Economics, 1969), pp. 72–80.
5.
BeaverW.KettlerP.ScholesM., “The Association between Market Determined and Accounting Determined Risk Measures,”The Accounting Review (October 1970), pp. 654–682.
6.
BenstonG. J., Conglomerate Merger: Causes, Consequences and Remedies (Washington, D.C.: American Enterprise Institute for Public Policy Research, 1980).
7.
BettisRichardA., “Performance Differences in Related and Unrelated Diversified Firms,”Strategic Management Journal (1981), pp. 379–393.
8.
BettisRichardA.HallWilliam K., “Diversification Strategy, Accounting Determined Risk, and Accounting Determined Return,”Academy of Management Journal, 25, no. 2 (June 1983), pp. 254–264.
9.
BettisRichardA.MahajanVijay, “Risk/Return Performance of Diversified Firms,”Management Science, 31, no. 7 (July 1985), pp. 785–799.
10.
BowmanR. G., “The Theoretical Relationship between Systematic Risk and Financial (Accounting) Variables,”Journal of Finance (June 1979), pp. 617–629.
11.
BowmanR. G., “The Debt Equivalence of Leases: An Empirical Investigation,”The Accounting Review (April 1980a), pp. 237–253.
12.
BowmanR. G., “The Importance of a Market-Value Measurement of Debt in Assessing Leverage,”Journal of Accounting Research (Spring 1980b), pp. 515–539.
13.
ChristensenKurtH.MontgomeryC. A., “Corporate Economic Performance: Diversification Strategy versus Market Structure,”Strategic Management Journal, 2 (1981), pp. 327–343.
14.
CoaseR. H., “The Value of the Firm,”Economica, 4 (1937), pp. 331–351.
15.
DyckmanT.PhilbrickD.StephanJ., “A Comparison of Event Study Methodologies Using Daily Stock Returns: A Simulation Approach,”Supplement to the Journal of Accounting Research, 22 (1984), pp. 1–30.
16.
Financial Accounting Standards Board, Statement No. 14, Financial Reporting for Segments of a Business Enterprise (Stamford, Conn.: FASB, December 1976).
17.
GalaiD.MasulisR. W., “The Option Pricing Model and the Risk Factor of Stock,”Journal of Financial Economics, 3 (January–March 1976), pp. 53–81.
18.
GortM., Diversification and Integration in American Industry (Princeton, N.J.: Princeton University Press, 1962).
19.
HamadaR. S., “The Effect of the Firm Capital Structure on the Systematic Risk of Common Stock,”Journal of Finance (May 1972), pp. 435–452.
20.
HigginsR. C.SchallL. D., “Corporate Bankruptcy and Conglomerate Merger,”Journal of Finance, 30 (March 1975), pp. 93–114.
21.
HurdleG. J., “Leverage, Risk, Market Structure and Profitability,”The Review of Economics and Statistics, 56 (1974), pp. 478–485.
22.
LevB., “On the Association between Operating Leverage and Risk,”Journal of Financial and Quantitative Analysis (September 1974), pp. 627–642.
23.
LevyH.SarnatM., “Diversification, Portfolio Analysis and the Uneasy Case for Conglomerate Mergers,”Journal of Finance (September 1970), pp. 795–802.
24.
LewellenW. G., “A Pure Financial Rationale for Conglomerate Mergers,”Journal of Finance, 26 (May 1971), pp. 521–537.
25.
MarkhamJ. W., Conglomerate Enterprise and Economic Performance (Cambridge, Mass.: Harvard University Press, 1973).
26.
MontgomeryC. A.“The Measurement of Firm Diversification: Some New Empirical Evidence,”Academy of Management Journal, 25, no. 2 (1982), pp. 299–307.
27.
MontgomeryC. A.SinghH., “Diversification Strategy and Systematic Risk,”Strategic Management Journal, 5 (1984), pp. 181–191.
28.
MoyerR. C.ChatfieldR., “Market Power and Systematic Risk,”Journal of Economics and Business, 33, no. 1 (1981).
29.
PalepuK., “Diversification Strategy, Profit Performance and the Entropy Measures,”Strategic Management Journal, 6 (1985), pp. 239–255.
30.
PenmanS. H., “Abnormal Returns to Investment Strategies Based on the Timing of Earnings Reports,”Journal of Accounting and Economics, 6 (1984), pp. 165–183.
31.
RumeltR. P., Strategy, Structure and Economic Performance (Cambridge, Mass.: Harvard University Press, 1974).
32.
RumeltR. P., “Diversification Strategy and Profitability,”Strategic Management Journal, 3 (1982), pp. 359–369.
33.
SchererF. M., Industrial Market Structure and Economic Performance (Chicago: Rand-McNally, 1980).
34.
SteinerP. O., Mergers: Motives, Effects, Policies (Ann Arbor: University of Michigan Press, 1975).
35.
SubrahamanyamM. G.ThomadakisS. B., “Systematic Risk and the Theory of the Firm,”The Quarterly Journal of Economics (May 1980), pp. 437–451.
36.
TeeceD. J., “Towards an Economic Theory of the Multiproduct Firm,”Journal of Economic Behavior and Organization, 3 (1982), pp. 39–63.
37.
WilliamsonE. E., Markets and Hierarchies (New York: Free Press, 1975).
38.
WrightS., “Correlation and Causation,”Journal of Agricultural Research, 20 (1921), pp. 559–585.
