The authors thank Arnold Cowan (the editor), two anonymous referees, Lemma Senbet, Laurence Booth, Ted Fee, Paul Halpern, Tom McCurdy, Oyvind Norli, Urs Peyer, Vasu Ramanujam, Peter Ritchkin, David Schirm, Betty Simkins, Ajai Singh, James Thomson, John Thornton and participants at the 2004 Financial Management Association annual meetings, University of Toronto Capital Markets Workshop, the Case Western Reserve University Banking and Finance Seminar, the Kent State University Finance Research Seminar Series and the Federal Reserve Bank of Cleveland Research Seminar Series for valuable comments. However, any errors in this paper remain ours.
The Diversification Discount Puzzle: Evidence for a Transaction-Cost Resolution
Article first published online: 18 JAN 2009
© 2009, The Eastern Finance Association
Volume 44, Issue 1, pages 113–135, February 2009
How to Cite
Aggarwal, R. and Zhao, S. (2009), The Diversification Discount Puzzle: Evidence for a Transaction-Cost Resolution. Financial Review, 44: 113–135. doi: 10.1111/j.1540-6288.2008.00212.x
- Issue published online: 18 JAN 2009
- Article first published online: 18 JAN 2009
- corporate diversification;
- transaction-cost economics;
- internal capital markets
The literature on the corporate diversification discount and the relative efficiency of internal versus external capital markets provides mixed results. We argue that transaction-cost economics is useful in understanding this puzzle. According to transaction-cost economics, diversified firms should outperform single segment firms in industries with higher external transaction costs (e.g., emergent industries) and under-perform in industries with low external transaction costs and high agency and other internal costs (e.g., some mature industries). This paper provides evidence supporting these contentions.