ARP (Company Valuation): Diversification Discount on Firm Value
Prior research finds that compared to focused firms (i.e., with a single business segment), diversified firms (i.e., with multiple business segments) are valued at a discount. This phenomenon is referred to as the diversification discount on firm value (Berger and Ofek 1995). Although different explanations to the phenomenon have been put forth, the discount is still not fully explained (Campa and Kedia 2002). Recently, a study based on mergers and acquisitions accounting is able to fully explain the discount measured in terms of an asset-based valuation multiple (Custodio 2014). However, the explanation does not apply to a sales-based valuation multiple with which the diversification discount has also been documented. Therefore, the mystery remains not fully solved.
Students of this group will first replicate the diversification discount result of prior research. Building on the replicated result, they will then try to explore factors that might be related to the diversification discount. Potential factors include, but are not limited to, the examples below:
• earnings quality
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• corporate governance
• audit-related characteristics • disclosure concerns
• industry characteristics
• any other relevant factors
Students will use an appropriate research design to examine a research question under the theme of this group. They are expected to conduct the research using US research databases on Data Services (WRDS), such as CRSP-Compustat (merged), Compustat Historical Segments, FactSet Stock Ownership, (13f) Holdings, and Audit Analytics, because other countries usually do not have the required data on segment reporting. Students need to invest sufficient time to understand the definitions of relevant data items before selecting the correct items for use in the analysis. They must learn to use an R demo code, provided on RStudio Cloud, for generating the required Excess Value variables for their chosen sample period for completing the project.
Related readings (more materials in a shared folder on OneDrive):
Berger, P.G., Ofek, E., 1995. Diversification’s effect on firm value. Journal of Financial Economics 37, 39–65. https://doi.org/10.1016/0304-405X(94)00798-6
Berger, P.G., Hann, R., 2003. The Impact of SFAS No. 131 on Information and Monitoring. Journal of Accounting Research 41, 163–223. https://doi.org/10.1111/1475-679X.00100
Berger, P.G., Hann, R.N., 2007. Segment Profitability and the Proprietary and Agency Costs of Disclosure. The Accounting Review 82, 869–906. https://doi.org/10.2308/accr.2007.82.4.869
Campa, J.M., Kedia, S., 2002. Explaining the Diversification Discount. The Journal of Finance 57, 1731–1762. https://doi.org/10.1111/1540-6261.00476
Custodio, C., 2014. Mergers and Acquisitions Accounting and the Diversification Discount. The Journal of Finance 69, 219–240. https://doi.org/10.1111/jofi.12108
Dubner, T., Feldman, E.R., Shapiro, E., Pernsteiner, T., Sarma-Rupavtarm, R., 2018. Can your valuation be improved? URL https://advisory.kpmg.us/content/dam/advisory/en/pdfs/can-your- valuation-be-improved.pdf (accessed 11.9.20).
Feldman, E.R., 2016a. Corporate spinoffs and analysts’ coverage decisions: The implications for diversified firms. Strategic Management Journal 37, 1196–1219. https://doi.org/10.1002/smj.2397 Feldman, E.R., 2016b. Corporate Spin-Offs and Capital Allocation Decisions. Strategy Science 1,
256–271. https://doi.org/10.1287/stsc.2016.0022
Feldman, E.R., Gilson, S.C., Villalonga, B., 2014. Do analysts add value when they most can?
Evidence from corporate spin-offs. Strat. Mgmt. J. 35, 1446–1463. https://doi.org/10.1002/smj.2169
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