Extract
The market impact of change in corporate diversification (focus): some new evidence.
ABSTRACT
Market reaction to seasoned equity issue is mostly negative but the effect of the level of a firm's diversification on the market response is not clearly understood. This paper examines the impact of corporate diversification on seasoned equity offerings. It has been found that for high focused (i.e. less diversified) firms market reaction is less negative. But when the relationship between the change in focus and market impact is examined, it is observed that market reacts more negatively to firms which have increased their focus in the recent past. This finding supports the arguments of both information asymmetry and free cash flow theories. 1. INTRODUCTION Corporate diversification through acquisition or other means is the source of external growth and an indicator of the company's organizational and structural changes. But the impact of corporate diversification and more importantly change in the level of diversification (focus) on the market reaction to the seasoned equity offerings, has not received much attention. Two of the most pertinent research questions are: 1) Does diversification affect shareholders' wealth, and 2) what is the effect of diversification on information asymmetry between managers and shareholders, and consequently on the value of seasoned equity offerings. Empirical evidence regarding the effect of diversification on the value of the firm is not conclusive. Weston (1970) and Williamson (1975) argue that diversified firms are more profitable because of their ability to pool internally generated funds and allocate them properly. For diversified firms economies of scale [Teece (1980)] and efficient allocation of resources [Stein (1997)] are expected to have a positive impact on valuation. Lewellen (1971) showed the benefit of coinsurance through...See the full content of this document
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