Capital Market Development, Legal Systems and the Value of Corporate Diversification: A Cross-Country Analysis

Using a database of more than 8,000 companies from 35 countries, we find that the value of corporate diversification is negatively related to the level of capital market development. Among high-income countries, where capital markets are well developed, we find a significant diversification discount. By contrast, for the lower income countries, we find that there is either no diversification discount or a diversification premium. For these firms, the benefits of diversification appear to offset the agency costs of diversification. We also find that the value of corporate diversification varies with legal systems. In particular, we find that diversification discounts are largest among countries where the legal system is of English origin. We find smaller diversification discounts in countries where the legal system is of German, Scandinavian, or French origin. Overall, our results suggest that the financial, legal, and regulatory environment all have an important influence on the value of diversification, and that the optimal organizational structure for firms operating in emerging markets may be very different than that for firms operating in more developed countries.