Financing effects of corporate diversification: A review

Prior review papers on corporate diversification have mostly explored the diversification-performance linkage but not the effects of diversification on various financing aspects of firms. By addressing this gap in the extant literature, our review aims to support entrepreneurs/managers in decision-making related to diversification, organizational form, and structuring. For investors, it highlights potential risks that diversification could expose them to. To this end, we propose an integrated framework that considers both conglomerates and business groups (BG) as diversifying organizational forms. We find that diversification impacts financing through two channels: financial synergies and internal capital markets (ICM). Broadly, financial synergies reduce the probability of default on a firm’s debt, thereby increasing its capital-raising ability. However, diversification can also lead to risk contamination and loss of limited liability benefits. ICMs relax financial constraints, facilitate propping of distressed business lines, and provide resilience during economic downturns. Unlike conglomerates, BG affiliated firms are often controlled through pyramidal structures. Pyramidal structures create divergences between control rights and cash-flow rights, thereby enabling expropriation of minority shareholders. However, such structures can also facilitate financing of growth opportunities from within the group. Finally, we propose certain avenues for future research.