Corporate Diversification And Diversification Discount

The discussion on corporate diversification and diversification discount is one of the important topics in financial economics. The negative relationship between diversification and firm performance (firm value) measured by Tobin's q is referred as to diversification discount. This is a very important finding. After the studies of Wernerfelt and Montgomery( (1988) ,Lang and Stulz(1994) and Berger and Ofek(1995), many researchers have tried to give the theoretical and empirical explanation on the finding. Hereinto, agency theory applies the conflict between manager and stockholders to eliciting on how the managerial diversification motives destroy firm value, which, therefore, cause the diversification discount. Internal capital market theory indicates that agency conflict and information asymmetry may lead to the capital misallocation in internal markets. But on the other hand, internal capital market may allocate resources efficiently. This theory explain well why some firms have diversification discounts, but others not. The optimal diversification theory suggests that, although there exist diversification discounts, diversification does not cause diversification discount, diversification is the firms' optimal strategy choice. Besides, some papers attribute diversification discount to the sample selection and measurement errors, when the factors are controlled well, diversification discount is diminished or disappears, even turn into premium.Based on China's practice, this article extends corporate diversification theory. The agency relationship between controlling stockholders and minority stockholders in introduced to analysis the diversification motive, and investor protection theory is used to annotate internal capital markets. And firm specific resources are endowed with the time-varying characteristics, therefore, to explain the Chinese firm diversification choice. Finally, through some empirical analyses, I give the answer to the question whether or not there exist diversification discount, and offer relevant explanations.