Puzzle of corporate diversification efficiency in BRIC countries
Abstract
Phenomenon of corporate diversification has been actively discussing in financial academic
literature. For a long time such business strategy was viewed as rational and effective model, but later
many countries have taken “return to focus” as wholesome and compelling corporate doctrine.
According to empirical results in developed countries, the prevailing wisdom among financial
researches has been that diversified firms sell at a discount and the level of corporate diversification has
been trending downward (Berger, Ofek, 1995; Lang, Stulz, 1994; Fukui, Ushijima, 2007). Frequently,
internal capital market and high agency costs have been viewed as sources of the value loss (Rajan et
al., 2000; Scharfstein, Stein, 2000; Gautier, Heider, 2002; Inderst, Laux, 2005; Brusco, Panunzi, 2005;
Erdorf et al., 2013). However, recent researches question both mentioned results. A number of studies
now suggest that the observed discount is attributable to factors others than diversification, or may be a
result of improper measurement techniques (Villalonga, 1999); Graham et al., 2002; Campa, Kedia,
2002; Pal, Bohl, 2005, Beckmann et al., 2006, Glegg et al., 2010).
Whereas corporate diversification has negative impact on firm value for firms based in
developed countries this strategy may be valuable for companies that operate in emerging capital
markets. These markets are characterized as a rule by a dominance of diversified companies. The
specific features of emerging markets, to some extent, can affect the effectiveness of integration
strategy. In developed countries well-developed structures in capital market, competitive product
market and labor markets as well as strong contract enforcement guarantee similar rules of play for
both diversified and focused firms. In these conditions benefits of integration may be reduced. On the
contrary, in an imperfect institutional environment like emerging markets and with weak enforcement
of contracts diversified firms may be of value. They can mimic the beneficial functions of various
institutions that are present in developed markets and thereby create a potential source of value growth
for integrated firms (Khanna, Palepu, 1997). But on the other hand severe market imperfections which
increase the potential agency costs resulting from higher information asymmetry can lead to value
destruction in firms that undertake such strategies. Consequences of corporate diversification are less
explored in emerging markets, the but most of the existing researches confirm that benefits associated
with diversification outweigh the costs (Fauver et al., 2003; Claessens, et al., 2001; Khanna, Palepu,
2000; Perotti, Gelfer, 2000, Bae et al., 2006; Mursitama, 2006; Kuppuswamy et al., 2012). Some
studies examine the instability of diversification premium (Lee et al., 2008).
We contribute to existing literature by analyzing the corporate diversification phenomenon on
the sample of companies from BRIC countries. In line with other studies we distinguish between
related and unrelated diversification and in contrast to them we single out and separately examine the
vertical integration. We also examine the main determinants of the market reaction to the
announcements of corporate diversification to understand the market pricing process of diversification
strategy. So, this article adds to the growing body of literature on corporate diversification in emerging
markets.
To study the link between corporate diversification and firm value on the sample of companies
from BRIC countries, we use a two-step procedure. First, we analyze the consequences of corporate
diversification using the event study method. Second, the abnormal returns are then used as the
depended variables in regression models in order to explain the cross-sectional variation in abnormal
returns.
We use the Zephyr Mergers and Acquisitions database to identify an initial sample of 3172
publicly traded deals that fit into the categories of complete, announce or pending transaction during
the period of 2000-2013. We further require that (1) only acquirers are publicly traded firms, (2) the
acquiring firm controls less than 50% of the shares of the target firm before the announcement, (3) the
relative transaction size is higher than five percent, (4) acquirer’s closed prices are available for us, (5)
there is a lack of significant corporate events in estimation period, such as shares buyback, other
mergers and acquisitions and joint ventures.
Our requirements yield the sample of 300 transactions. We group firms according to
diversification type – related and unrelated, using SIC-code classification (Berger, Ofek, 1995; Denis et
al., 1997). If the acquirer and the target have no commonality in first three digits of four-digit SIC
codes, the acquisition is classified as unrelated. Other deals are classified as related diversification. For
our sample, 138 of the acquisitions are related, 162 are unrelated deals. Unfortunately, SIC
classification doesn’t allow singling out vertical integrated firms and often referring them to unrelated
diversification. To identify such firms we use the input-output tables at the US Bureau of Economic
Analysis to create a matrix of vertical relatedness at the industry level (Fan, Lang, 2000; Claessen et al.,
2001). As a result 63 acquisitions are considered as vertical, 105 – as conglomerate, and 132- as
horizontal M&A.
We are testing the following hypotheses on the pre-crisis and post-crisis periods (2000-mid2008;
mid2009-2013):
H1 Corporate diversification doesn’t destroy value of a firm ( CAR diversification  0 ).
H2 Corporate diversification doesn’t destroy value of a firm irrespective of diversification type. In case
of
related
diversification
CAR related _ diversification  0 .
In
case
CAR unrelated _ diversification  0 . In case of vertical integration CARvertical ³ 0 .
of
unrelated
diversification
H3 Acquisition abnormal returns are related to bidder Tobin’s Q.
H4 Acquisition abnormal returns are related to bidder financial leverage.
H5 Acquisition abnormal returns are related to deal size.
H6 Acquisition abnormal returns are related to bidder size.
H7 Acquisition abnormal returns are related to bidder operating performance.
We find support for our first hypothesis analyzing the pre-crisis period. Cumulative abnormal
returns (CAR) for the entire sample are positive (5,98%) and statistically significant at 1 per cent level.
We also find that corporate diversification doesn’t destroy value of a firm irrespective of diversification
type. CAR are positive for related (6,72% at the 0.01 level), unrelated (3,72% at the 0.1 level) and
vertical (8.92% at the 0.01 level) acquisitions. For the subsample of M&A deals with unrelated
diversification we show that the bidders Tobin’s Q and financial leverage are the key determinants of
M&A performance. Analyzing the post-crisis period we find that market reaction to the announcements
of corporate diversification hasn’t significantly changed.