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Debt, Diversification, and Valuation

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  • William Ruland
  • Ping Zhou

Abstract

The separate associations between financial leverage and valuation and between diversification and valuation have been widely researched. The joint function of leverage, diversification, and valuation, however, has received much less attention. Previous research shows that compared to specialized firms, diversified firms tend to have higher free cash flows and fewer high net present value investment opportunities. Consequently, the agency costs associated with potential overinvestment are greater for diversified firms. The literature also proposes that financial leverage should reduce agency costs. Consequently, we expect that the values of diversified firms increase with leverage. Our tests provide strong support for the hypothesis that the values of diversified firms increase with leverage. This tendency is not observed for specialized firms. Copyright Springer Science + Business Media, Inc. 2005

Suggested Citation

  • William Ruland & Ping Zhou, 2005. "Debt, Diversification, and Valuation," Review of Quantitative Finance and Accounting, Springer, vol. 25(3), pages 277-291, November.
    • Handle: RePEc:kap:rqfnac:v:25:y:2005:i:3:p:277-291
    DOI: 10.1007/s11156-005-4768-0
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    References listed on IDEAS

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    Cited by:

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    4. Ruey Tsay & Yi-Mien Lin & Hsiao-Wen Wang, 2008. "Residual income, value-relevant information and equity valuation: a simultaneous equations approach," Review of Quantitative Finance and Accounting, Springer, vol. 31(4), pages 331-358, November.
    5. Zaheda Daruwala, 2023. "Influence of Financial Leverage on Corporate Profitability: Does it Really Matter?," International Journal of Economics and Financial Issues, Econjournals, vol. 13(4), pages 37-46, July.
    6. Jagjeevan Kanoujiya & Pooja Jain & Souvik Banerjee & Rameesha Kalra & Shailesh Rastogi & Venkata Mrudula Bhimavarapu, 2023. "Impact of Leverage on Valuation of Non-Financial Firms in India under Profitability’s Moderating Effect: Evidence in Scenarios Applying Quantile Regression," JRFM, MDPI, vol. 16(8), pages 1-20, August.
    7. Ana Belén Tulcanaza-Prieto & Younghwan Lee & Wendy Anzules-Falcones, 2024. "The Moderating Role of Corporate Governance in the Relationship between Leverage and Firm Value: Evidence from the Korean Market," Risks, MDPI, vol. 12(1), pages 1-19, January.
    8. Mukhoti, Sujay & Guhathakurta, Kousik, 2015. "Product market performance and capital structure: A Hierarchical Bayesian semi-parametric panel regression model," MPRA Paper 62517, University Library of Munich, Germany.
    9. Olayinka Akinlo & Taiwo Asaolu, 2012. "Profitability And Leverage: Evidence From Nigerian Firms," Global Journal of Business Research, The Institute for Business and Finance Research, vol. 6(1), pages 17-25.
    10. Mercè Sala‐Ríos, 2024. "What are the determinants affecting cooperatives’ profitability? Evidence from Spain," Annals of Public and Cooperative Economics, Wiley Blackwell, vol. 95(1), pages 85-111, March.
    11. Cheng-Few Lee & Woan-lih Liang & Fu-Lai Lin & Yating Yang, 2016. "Applications of simultaneous equations in finance research: methods and empirical results," Review of Quantitative Finance and Accounting, Springer, vol. 47(4), pages 943-971, November.
    12. Fosu, Samuel, 2013. "Capital structure, product market competition and firm performance: Evidence from South Africa," The Quarterly Review of Economics and Finance, Elsevier, vol. 53(2), pages 140-151.
    13. Seongtae Kim & Sangho Chae, 2022. "Shareholder Value Effects of Ethical Sourcing: Comparing Reactive and Proactive Initiatives," Journal of Business Ethics, Springer, vol. 179(3), pages 887-906, September.
    14. Florence André-Le Pogamp & Frédéric Perdreau, 2009. "Stratégies de diversification et structure du capital," Revue Finance Contrôle Stratégie, revues.org, vol. 12(4), pages 5-38, December.
    15. M N, Nikhil & S Shenoy, Sandeep & Chakraborty, Suman & B M, Lithin, 2023. "Is the Nexus Between Capital Structure and Firm Performance Asymmetric? An Emerging Market Perspective," MPRA Paper 119669, University Library of Munich, Germany, revised 17 Nov 2023.
    16. Bassam M. Abu-Abbas, Turki Alhmoud, Fatima A. Algazo, 2019. "Financial leverage and firm performance: evidence from Amman stock exchange," European Journal of Comparative Economics, Cattaneo University (LIUC), vol. 16(2), pages 207-237, December.
    17. 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).
    18. Adel Bino & Elisabeta Pana, 2011. "Firm value and investment policy around stock for stock mergers," Review of Quantitative Finance and Accounting, Springer, vol. 37(2), pages 207-221, August.
    19. Chee Lim & Tiong Thong & David Ding, 2008. "Firm diversification and earnings management: evidence from seasoned equity offerings," Review of Quantitative Finance and Accounting, Springer, vol. 30(1), pages 69-92, January.
    20. Liu-Ching Tsai & Chaur-Shiuh Young & Hui-Wen Hsu, 2011. "Entrenched controlling shareholders and the performance consequences of corporate diversification in Taiwan," Review of Quantitative Finance and Accounting, Springer, vol. 37(1), pages 105-126, July.
    21. Yu-Yen Ku & Tze-Yu Yen, 2016. "Heterogeneous Effect of Financial Leverage on Corporate Performance: A Quantile Regression Analysis of Taiwanese Companies," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 19(03), pages 1-33, September.
    22. Thang Nguyen & Charlie X. Cai & Patrick McColgan, 2017. "How firms manage their cash flows: an examination of diversification’s effect," Review of Quantitative Finance and Accounting, Springer, vol. 48(3), pages 701-724, April.

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