Does Corporate Diversification Destroy Value?

We analyze several hundred firms that expand via acquisition and0or increase their number of business segments. The combined market reaction to acquisition announcements is positive but acquiring firm excess values decline after the diversifying event. Much of the excess value reduction occurs because our sample firms acquire already discounted business units, and not because diversifying destroys value. This implies that the standard assumption that conglomerate divisions can be benchmarked to typical stand-alone f irms should be carefully reconsidered. We also show that excess value does not decline when firms increase their number of business segments because of pure reporting changes. DOES CORPORATE DIVERSIFICATION destroy value? Several recent papers attempt to answer this question by comparing the market value of firms that operate multiple lines of business to the value of a portfolio of stand-alone firms operating in the same industries as the conglomerate’s divisions. Lang and Stulz ~1994! use this approach and find that multisegment firms have low values of Tobin’s q compared to stand-alone firms. Similarly, Berger and Ofek ~1995! find that U.S. conglomerates are priced at a mean discount of about 15 percent. Lins and Servaes ~1999! find similar discounts in Japan and the United Kingdom. Indeed, based on the Berger and Ofek methodology, diversified firms with valuation discounts had aggregate value losses of $800 billion in 1995. The magnitude of the value loss suggests that operating the divisions of conglomerates as stand-alone firms would create significant value. In this paper, we provide new evidence on whether the act of corporate diversification destroys value, or whether the divisions that make up conglomerates would trade at a discount, even if they operated as standalone firms. * Graham is from Duke University, Lemmon is from the University of Utah, and Wolf is from Clemson University. We thank three anonymous referees, George Benston, Hank Bessembinder, Judy Chevalier, Rick Green, Owen Lamont, Gordon Phillips, Marlene Plumlee, Henri Servaes, René Stulz, and seminar participants at the 2000 NBER Corporate Finance Summer Workshop, and at Carnegie Mellon, Clemson, Emory, the University of Kentucky, the University of Texas–Austin, the University of Utah, William and Mary, the 2000 meetings of the Western Finance Association and the Southern Finance Association, and the 2001 meeting of the American Economics Association for helpful comments. Graham gratefully acknowledges financial support from the Alfred P. Sloan Research Foundation. THE JOURNAL OF FINANCE • VOL. LVII, NO. 2 • APRIL 2002