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Capital structure and corporate diversification: Is debt a panacea for the diversification discount?

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  • Fuente, Gabriel de la
  • Velasco, Pilar

Abstract

This study investigates the role of debt as an internal governance mechanism that can be employed by companies to curb agency conflicts and discourage managers from value-destroying diversification. Using a panel of U.S. firms, we find that leverage positively moderates the effect of diversification on a firm's value. We confirm that such an effect stems from the monitoring role of debt, which fosters efficiency in investments across segments and discourages cross-subsidization. Our investigation goes a step further by delving into the disciplinary role of debt and rationalizing certain scenarios that determine whether the effect of debt on the diversification-value relationship is stronger or weaker. We find such a moderating effect proves more beneficial for unrelated diversified companies and for firms with lower investment opportunities. However, the benefits of debt weaken in the presence of an alternative monitoring device (concentrated ownership), and when debt allocation becomes discretionary in highly diversified companies.

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  • Fuente, Gabriel de la & Velasco, Pilar, 2020. "Capital structure and corporate diversification: Is debt a panacea for the diversification discount?," Journal of Banking & Finance, Elsevier, vol. 111(C).
    • Handle: RePEc:eee:jbfina:v:111:y:2020:i:c:s0378426619303012
    DOI: 10.1016/j.jbankfin.2019.105728
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    7. Shane A. Dalsem, 2024. "Diversification across the life cycle of the firm: evidence from the IPO classes of 1998 and 1999," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 48(3), pages 777-797, September.
    8. Nur Mulyani Dwi Putri & Nurfauziah Nurfauziah, 2022. "The effect of ownership structure on the level of agency conflict: The moderating role of debt level," International Journal of Research in Business and Social Science (2147-4478), Center for the Strategic Studies in Business and Finance, vol. 11(5), pages 314-323, July.
    9. Velasco, Pilar, 2022. "Is bank diversification a linking channel between regulatory capital and bank value?," The British Accounting Review, Elsevier, vol. 54(4).
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    More about this item

    Keywords

    Corporate diversification; Capital structure; Agency theory; Overinvestment; Firm value;
    All these keywords.

    JEL classification:

    • C36 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Instrumental Variables (IV) Estimation
    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance

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