NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Cost of Diversity: The Diversification Discount and Inefficient Investment

Raghuram Rajan, Henri Servaes, Luigi Zingales

NBER Working Paper No. 6368
Issued in January 1998
NBER Program(s):   CF

In a simple model of capital budgeting in a diversified firm where headquarters has limited power, we show that funds are allocated towards the most inefficient divisions. The distortion is greater the more diverse are the investment opportunities of the firm's divisions. We test these implications on a panel of diversified firms in the U.S. during the period 1979-1993. We find that i) diversified firms mis-allocate investment funds; ii) the extent of mis-allocation is positively related to the diversity of the investment opportunities across divisions; iii) the discount at which these diversified firms trade is positively related to the extent of the investment mis-allocation and to the diversity of the investment opportunities across divisions.

download in pdf format
   (2301 K)

email paper

A non-technical summary of this paper is available in the September 1998 NBER digest.  You can sign up to receive the NBER Digest by email.

This paper is available as PDF (2301 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w6368

Published: Journal of Finance, Vol. 55, no. 1 (2000): 35-80.

Users who downloaded this paper also downloaded these:
Lamont and Polk w7396 The Diversification Discount: Cash Flows vs. Returns
Laeven and Levine w11499 Is There a Diversification Discount in Financial Conglomerates?
Scharfstein and Stein w5969 The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment
Lang and Stulz w4376 Tobin's Q, Corporate Diversification and Firm Performance
Scharfstein w6352 The Dark Side of Internal Capital Markets II: Evidence from Diversified Conglomerates
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us