IESE Research Papers,
IESE Business School

Abstract: Firm's boundaries have been one of the central questions in several research domains, but it is possible to affirm that a definitive consensus has not been reached to determine the relationship between diversification and firm's performance. We study this relationship according to the main empirical finding in strategy and finance but controlling for the persistence of abnormal returns. Through longitudinal studies, using both accounting and market indicators, we conclude that this relationship is not causal but attributable to factors other than the degree of relatedness among business units and the degree of efficiency of the internal capital market. The persistence of abnormal returns has a grater explanatory power: we find that some diversified firms persistently create shareholder value, beat the market index and have lower market volatility, while others persistently reach opposite results. Moreover, we find that higher performance is associated with an unrelated portfolio of business segments.

Keywords: diversification; abnormal return persistence; shareholder value and risk; efficient internal capital market; business segment relatedness

JEL-codes: L25

34 pages, February 7, 2011

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