Why Do Managers Diversify Their Firms? Agency Reconsidered


  • Rajesh K. Aggarwal,

  • Andrew A. Samwick

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    • * Aggarwal is at Dartmouth College and Samwick is at Dartmouth College and the NBER. We thank Sheri Aggarwal; Andres Almazan; Andrew Bernard; Diego Garcia; Charlie Had-lock; Kose John; Michael Knetter; Praveen Kopalle; Dominic LaValle; Dennis Logue; Joel Vanden; Jeff Zwiebel; and seminar participants at Dartmouth, Michigan, Michigan State, Stanford, Tufts, the 11th Annual FEA Conference, the Western Finance Association Meetings, and the American Finance Association Meetings for helpful comments. The referee and editor provided numerous comments that greatly improved the paper. We also thank Bob Burnham for assistance with COMPUSTAT and Andy Halula for assistance with the ExecuComp database. Any errors are our own.


We develop a contracting model between shareholders and managers in which managers diversify their firms for two reasons: to reduce idiosyncratic risk and to capture private benefits. We test the comparative static predictions of our model. In contrast to previous work, we find that diversification is positively related to managerial incentives. Further, the link between firm performance and managerial incentives is weaker for firms that experience changes in diversification than it is for firms that do not. Our findings suggest that managers diversify their firms in response to changes in private benefits rather than to reduce their exposure to risk.