Do diversified or focused firms make better acquisitions?

This paper examines the stock market’s reaction to merger and acquisition announcements to determine whether the market perceives that diversified or focused firms create more value when acquiring other firms. We also examine whether differences in merger announcements between diversified and focused firms explain differences in real firm performance following the merger. Diversified firms may create more value through acquisitions than focused firms if they have more experience creating operating synergy, more institutional learning from doing past acquisitions, or if they attract higher quality CEOs because they are larger and more complex firms offering higher compensation. Diversified firms may create less value through acquisitions than focused firms if diversified firms have more agency problems due to their complex organizational form or if they have weaker corporate governance. We find that the mean (median) of marketadjusted announcement returns to diversified acquirers is 1.5% (0.70%) higher than that of single segment acquirers. The mean (median) net gain for mergers done by diversified acquirers is $56 billion (15 billion) higher than that of single segment acquirers. We find evidence that the larger merger gains for diversified acquirers are primarily due to performance improvements resulting from larger cost reductions following the acquisitions.