International Evidence on the Value of Corporate Diversification

1
International Evidence on the Value of Corporate
Diversification

• Karl Lins and Henri Servaes
• Journal of Finance (1999)

2
1. Motivation and Objectives

• Diversification effect on firm value in Germany,
  Japan, and UK.
• Institutional environment in Germany and Japan is
  different from that in U.S. Agency problems may
  be less sever in these countries due to more
  concentrated ownership structure.

3
Motivation

• Differences in the corporate organizational
  structures in Germany and Japan
• Bank ownership is limited in Japan, but not in
  Germany.
• Many Japanese firms belong to industrial groups
  keiretsu. Not in Germany.
• Both countries lack an active takeover market,
  but have a strong internal control mechanism.
• U.K. system is similar to that in U.S.
• Bank ownership is limited by law and
  Intercorporate equity holdings are small.

4
Results

• The effect of diversification on firm value is
  different across countries.
• No evidence of diversification discount in
  Germany.
• A diversification discount of 10 and 15 for
  Japan and U.K.
• Is ownership concentration related to the
  diversification discount?
• Div. disc. shown only with insider ownership
  below 5.
• Insider ownership does affect the discount in
  Japan and UK.

5
Results

• In Japan, diversified firms do not trade at a
  discount unless they have a strong link with an
  industrial group.
• Diversified firms with a strong association trade
  at a discount of 30 percent.
• Overall, the value of diversification is related
  to the institutional structure of a country.

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Data and Methodology

• Worldscope database provides financial and
  ownership data from 37 countries.
• Diversification is defined at the two-digit
  level.

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Table II. Sample description
8
Valuation Methodology

• Used the method by Berger and Ofek (1995)
• Excess Value Ln (Actual value/Imputed Value)
• Used Capital/Sales
• Other control factors
• Firm size, profitability, growth opportunities.
• Regression Model
• Excess value b0 b1DIVdummy b2Size
• b3Operating Income/sales
• b4Capital Exp/sales e.

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Table III. Regression results

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Corporate Governance and Diversification

• Denis, Denis, and Sarin (1997) find that
  diversified firms have lower insider and
  blockholder ownership.
• But the relation between ownership and
  diversification discount is weak.
• Insider ownership
• Bank Ownership
• Other institutional ownership (pension funds,
  mutual funds, insurance companies)

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Summary of ownership structure

• In Germany.
• Corporations are the dominant owner in Germany,
  controlling 40 percent of the equity of other
  firms.
• 65 of all firms have corporate ownership in
  excess of 5. Insider ownership is 12.
• In Japan.
• Corporations are also the dominant owner in
  Japan. But they own only half the shares of their
  German counterparts.
• Insider ownership is about 3.5, while bank
  ownership is 12.

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Summary of ownership structure

• In U.K.
• Institutions other than banks are the largest
  shareholder in the U.K. with 17 of the stock.
• Insider ownership at 8 and other individuals at
  3.
• Does ownership structure explain the DD?
• Extended the previous regression to include
  ownership variables and interaction terms between
  ownership and diversification dummy.

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Table IV Ownership structure
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Table V Regression on ownership structure
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Summary from Table V.

• Ownership structure affects the benefits of
  diversification in Germany, but not in Japan nor
  the U.K.
• Find a relation for insider ownership only.
• Why not in Japan or the U.K.?

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Conclusions

• Significant differences in the valuation of
  diversified firms in Germany, Japan, and the U.K.
• Concentrated insider ownership enhances the value
  in Germany, but it does not affect it in Japan or
  the U.K.
• For Japan, the DC is only present for firms with
  a strong association to keiretsu organization.