The Effect of Institutional Factors on the Value of Corporate Diversification

Using a large sample of diversified firms from 38 countries we investigate the influence of several national-level institutional factors or ‘institutional voids’ on the value of corporate diversification. Specifically, we explore whether the presence of frictions in a country’s capital markets, labor markets, and product markets, affect the excess value of diversified firms. We find that the value of diversified firms relative to their single-segment peers is higher in countries with less efficient capital and labor markets, but find no evidence that product market efficiency affects the relative value of diversification. These results provide support for the theory of internal capital markets that argues that internal capital allocation would be relatively more beneficial in the presence of frictions in the external capital markets. In addition, the results show that diversification can be beneficial in the presence of frictions in the labor market.  Venkat Kuppuswamy is an Assistant Professor of Strategy and Entrepreneurship at University of North Carolina at Chapel Hill, George Serafeim is an Assistant Professor of Business Administration at Harvard Business School and Belen Villalonga is a Professor of Finance at New York University. We are grateful to participants at the FMA Napa Valley conference 2012, and seminar participants at UNC and Georgetown University for many helpful comments. All errors are our own. Contact emails: Venkat Kuppuswamy: [email protected]; George Serafeim: [email protected]; Belen Villalonga: [email protected].