Essays in corporate diversification and refocusing strategies

This dissertation is comprised of two essays in which I investigate the idea that cross-subsidization of poorly-performing units within conglomerates is a cause for the value loss from diversification. In the first essay, I document a significant curvilinear relation between the value of diversification and the firm's growth opportunities. At low levels of growth, the relation is positive, consistent with a reduction in the likelihood of both free cash flow problems and underinvestment. At high levels of growth the relation is negative, consistent with an increased cost of cross-subsidization. There is no range of growth for which the value of diversification is significantly positive, implying that the benefits of internal capital markets at best reduce the net costs of diversification. Further segment-level analysis supports the view that cross-subsidization of poorly-performing units is particularly costly for high-growth, diversified firms. In the second essay, I document that one source of the value gains from refocusing is the divestiture of poorly-performing units. These poorly-performing divisions affect firm value by being negative net present value investment opportunities on their own, and by adversely affecting the performance of the remaining divisions of the firm. The announcement returns from refocusing are negatively related to the operating performance of the divested assets prior to the refocusing.