Strategy and Structure: Explaning the Diversification Discount

In this paper we provide an explanation based on the conflict of interes between top management, middle management and shareholders of why firms adopt different diversification strategies and how they structure themselves to manage those diversification strategies. It es shown that when objectives are fully aligued, a descentralization organizational structure coupled with a related diversification strategy is adopted. Whereas when objectives are not fully aligned, firms send to be more centralized and more focused than when incentives are aligned. We use these results to suggest an explanation for the existence of diversification discount; i.e., the empirical observation that conglomerate firms trade at a discount relative to a portfolio of stand-alone firms in the same business segments that do not depend on inefficient internal capital allocations.