THE EFFECT OF DIVERSIFICATION ON FIRM VALUE: A PRE‐ AND POST‐ DIVERSIFICATION ANALYSIS

Although there are theoretical costs and benefits to corporate diversification, there is ample empirical evidence that the stock market views the costs to outweigh the benefits (Lang and Stulz (1994), Berger and Ofek (1995), Servaes (1996), etc.) These studies are cross‐sectional studies which compare diversified firms to specialized firms and examine valuation multiples. The studies find that diversified firms have lower valuation multiples than specialized firms. This is called the diversification discount. In this paper, a sample of U.S. firms which are specialized and then become diversified are examined. We do not find evidence of a long‐term reduction in firm value associated with diversification.