David J. Denis

GLOBAL DIVERSIFICATION, INDUSTRIAL DIVERSIFICATION, AND FIRM VALUE

Using a sample of 44,288 firm-years between 1984 and 1997, we document an increase in the extent of global diversification over time. This trend does not ref lect a substitution of global for industrial diversification. We also find that global diversification results in average valuation discounts of approximately the same magnitude as those for industrial diversification. Analysis of the changes in excess value associated with changes in diversification reveals that increases in global diversification reduce excess value, while reductions in global diversification increase excess value. These findings support the view that the costs of global diversification outweigh the benefits. A CONSIDERABLE FRACTION OF U.S. CORPORATIONS diversify their operations, either across multiple lines of business ~industrial diversification!, across different national markets ~global diversification!, or both. Over the past decade, an extensive academic literature has developed documenting the causes and consequences of industrial diversification. Studies in this literature report that, on average, diversified firms are valued at a discount relative to a portfolio of comparable, single-segment firms. This value discount appears to stem, in part, from inefficient investment policies. In addition, the evidence indicates a trend towards less industrial diversification since the mid1980s, as well as a gain in shareholder value associated with refocusing strategies.1 Because industrial diversification potentially benefits corporate managers through increased power and prestige, through compensation arrange*David Denis, Diane Denis, and Keven Yost are from the Krannert Graduate School of Management at Purdue University. We appreciate helpful suggestions received from Espen Eckbo; Laura Field; Rick Green; John McConnell; Ralph Walkling; an anonymous referee; and seminar participants at Miami, Northeastern, Notre Dame, Ohio State, Penn State, the University of Texas-Dallas, the Joint Symposium of the 11th Annual Conference on Financial Economics and Accounting, and the 7th Annual Mitsui Life Symposium on Global Financial Markets at the University of Michigan. This project has been funded in part by a summer research grant from Purdue University’s Center for International Business and Education Research ~CIBER!. 1 For evidence on the valuation effects of industrial diversification, see Lang and Stulz ~1994!, Berger and Ofek ~1995!, and Servaes ~1996!. Evidence on the investment policies of diversified firms can be found in Scharfstein ~1998!; Shin and Stulz ~1998!; Denis and Thothadri ~1999!; and Rajan, Servaes, and Zingales ~2000!. For evidence on the trend towards increased corporate focus and the valuation consequences of this increased focus, see Comment and Jarrell ~1995!. THE JOURNAL OF FINANCE • VOL. LVII, NO. 5 • OCTOBER 2002

Ownership structure and top executive turnover

Abstract We report that ownership structure significantly affects the likelihood of a change in top executive. Controlling for stock price performance, the probability of top executive turnover is negatively related to the ownership stake of officers and directors and positively related to the presence of an outside blockholder. In addition, the likehood of a change in top executive is significantly less sensitive to stock price performance in firms with higher managerial ownership. Finally, we document an unusually high rate of corporate control activity in the twelve months preceding top executive turnover. We conclude that ownership structure has an important influence on internal monitoring efforts and that this influence stems in part from the effect of ownership structure on external control threats.

The choice among bank debt, non-bank private debt, and public debt: evidence from new corporate borrowings

Using a sample of 1,560 new debt financings, we examine the choice among bank debt, non-bank private debt, and public debt. The primary determinant of the debt source is the credit qualit y of the issuer. Firms with the highest credit quality borrow from public sources, firms with medium credit quality borrow from banks, and firms with the lowest credit quality borrow from non-bank private lenders. Non-bank private debt thus plays a unique role in accommodating the financing needs of firms with low credit quality. In addition, the choice of debt source is (weakly) influenced by managerial discretion.

Entrepreneurial finance: an overview of the issues and evidence

Microbending loss is reduced and abrasion protection is afforded for optical fibers by relatively thick polymer coatings characterized in part by a preferred elastic tensile modulus and cold flow property. The coating process uses rapid cooling of a liquid application to promote rapid gelation or solidification and thus achieve uniform coating diameter without beading. Fibers so coated are formed into ribbon structures having definite center-to-center fiber spacing. Preparation of coated fibers or ribbon structures for splicing is achieved by solvent stripping of the coating.

Majority owner-managers and organizational efficiency

Abstract By virtue of their ownership position, majority owner-managers appear to be less constrained than managers of firms with more diffuse ownership structures. Despite this, there is no evidence that majority-owned firms perform poorly and there is evidence that majority ownership is surviving as an organizational form. This implies that either these firms substitute other organizational constraints on managerial behavior or that majority control is efficient for some firms. Our analysis uncovers no evidence that majority owner-managers are constrained by other organizational mechanisms. We find that the choice of majority ownership is related to owner-specific rather than firm-specific characteristics. Approximately 80% of the sample majority-owned firms are either characterized by family involvement or are managed by the founder of the firm. Once this family/founder involvement in managing the firm diminishes, the firm is significantly less likely to be majority-controlled.

Active investors and management turnover following unsuccessful control contests

Abstract We report that 34% of targets of unsuccessful control contents between 1983 and 1989 experience a change in top manager within two years following the contest. Management turnover is concentrated among poorly performing firms in which outside blockholders acquire an ownership stake. These blockholders appear to facilitate post-contest asset restructurings that increase the value of the target and improve operating performance. In the absence of an outsider blockholder, managers typically retain their positions despite poor pre-contest performance and the use of value-reducing defensive tactics during the control contest. We conclude that monitoring by active outside investors facilitates valuable internal control efforts.

Investment Opportunities and the Market Reaction to Equity Offerings

This paper examines the relation between the market reaction to primary seasoned equity offerings and alternative measures of the profitability of the issuing firms growth opportunities. While the sample offerings display a positive relation between announcement period prediction errors and several ex ante measures of growth opportunities, this relation is not monotonic and appears to be driven by a small subset of younger, higher growth firms, whose announcement effects are insignificantly different from zero. For the remainder of the sample firms, there is no relation between the estimated profitability of new investment and the market reaction to announced equity offerings. Moreover, announcement effects are nonpositive regardless of how profitable investment opportunities are expected to be. These findings collectively suggest that investment opportunities play, at best, a minor role in explaining the cross-sectional distribution of equity offering announcement effects.

Agency theory and the influence of equity ownership structure on corporate diversification strategies

We articulate the agency theory view of managerial decision making and its implications for corporate diversification strategies. From agency theory, we generate testable predictions for the relation between equity ownership structure and diversification strategies and review the existing evidence on this relation. On balance, the evidence strongly supports the view that ownership structure influences corporate strategy. Copyright

Causes of Financial Distress Following Leveraged Recapitalizations

We report that 31% of the firms completing leveraged recapitalizations between 1985 and 1988 subsequently encounter financial distress. Following their recaps, the distressed firms exhibit (1) poor operating performance due largely to industry-wide problems, (2) surprisingly low proceeds from asset sales, and (3) negative stock price reactions to economic and regulatory events associated with the demise of the market for highly-leveraged transactions. The incidence of distress is not related to several characteristics that have previously been linked with poorly-structured deals. We thus attribute the high rate of distress primarily to unexpected macroeconomic and regulatory developments.

Managerial discretion, organizational structure, and corporate performance: A study of leveraged recapitalizations

Abstract We examine the impact of highly leveraged transactions on managerial discretion over investment policy using a sample of 39 proposed leveraged recapitalizations. We find significant decreases in undistributed cash flow, capital expenditures, and total assets following completed recapitalizations. The reductions in investment are significantly correlated with the cumulative abnormal returns earned by the shareholders of the recapitalizing firms. Moreover, we find evidence of poor investment decisions on the part of the sample firms in the years leading up to the recapitalizations. The overall results are consistent with the hypothesis that increased debt plays a valuable role in limiting managerial discretion.