Does Diversification Destroy Value? Evidence from Industry Shocks

Does corporate diversification reduce shareholder value? Since firms endogenously choose to diversify, exogenous variation in diversification is necessary in order to draw inferences about the causal effect. We examine changes in the within-firm dispersion of characteristics, or "diversity." Following the inefficient internal capital markets hypothesis, we examine investment diversity. We find that exogenous changes in diversity, due to changes in industry investment, are negatively related to changes in firm value. Thus diversification destroys value. This finding is not caused by measurement error. We also find that exogenous changes in industry cash flow diversity are negatively related to changes in firm value.