Optimal Diversification: Empirical evidence from the banking industry
Post by MSF Chula at Sunday, 10 January 2021 06:19 PM

This study investigates the effect of expected prospect, proxied by Tobin’s q, on the decision to diversify using worldwide data on the announcements of M&A by banks during 1990-2018. We focus on the banks diversifying into related businesses within the financial sector. We find some evidence to support the implication from a neoclassical view of efficient diversification that firms can optimally diversify at the stage of less productivity in ongoing activities. Separated into two sub-periods, during 1990-2007, the decision to diversify is endogenous to the banks’ exhausted growth opportunities in their core activities. Whereas, the exogenous factor, especially regulatory shock that restrains banks to exploit growth opportunity(leading to so-called underinvestment problem), could be the force that drives bank to diversify with desire to create internal capital market during 2008-2018. Despite different explanations for what drive banks to diversify, the banks diversify with intention to avoid expected poor prospects in their core activities. Inconsistent with the inefficient diversification argument (e.g., agency problems), the evidence from positive announcement-period returns to diversifying banks confirms thatthe market does not expect banks’ decision to diversify into a related business to destroy shareholder value.

Last updated at Sunday, 10 January 2021 06:19 PM