Diversification And Capital Structure: Management Strategy Or Investors Infringement?

The relationship between diversification and capital structure is complex. Based on the analysis of the panel data of China's firms from 2000 to 2006, this paper tests the relationship through cross-section of data, fixed effects panel data model and the danamic structure model. We find that coinsurance theory and internal capital market theory cann't explain the diversification behavior of China's listed firms. Capital structure and diversification strategy of China's listed firms interact each other. The increase of diversification might increase information asymmetry between the creditor and the company, then enhance the debt ability of the company, and cause the increase of capital structure while the increase of capital structure restricts diversification in return, and makes it decline. There is a negative correlation between diversification and the size of the company, so is diversification and the profit ability. Further research shows that it is not because the low profit or small size company likely adopts diversification, but because diversification canl lead to the decline of the profit and size of the company, which shows that the increased debt financing from diversification is maily transferred to the key industry of the company, but doesn't gain good performance. Thus the influential course between diversification and capital structure might infringe the creditors' and investors' benefit.