Wealth creation through corporate diversification – the bondholders’ perspective

Abstract

The influence of corporate diversification on firm value is an important field in strategy research. Studies in strategic management and finance research have analyzed value creation through product and geographic diversification from a shareholder’s perspective. This study completes this picture by analyzing the bondholders’ perspective. It is suggested that product diversification creates value for bondholders, while geographic diversification destroys bondholder value. The hypotheses are tested on a sample of S&P 1,200 firms in 2001–2011 using a fixed-effects panel model. Drawing on prior research, bondholder value creation is measured using the Merton model. The empirical results support the hypothesis that bondholders gain value through product diversification but lose value through geographic diversification. Considering prior research results, these results show that product diversification is preferable for bondholders, while geographic diversification is preferable from a shareholder’s perspective. The opposite effects of both diversification strategies on shareholders, respectively, bondholders offer an important new perspective on corporate diversification. The results show that firms with a high level of corporate debt should struggle to justify a strategy involving geographic dispersion of activities and support a more diversified product portfolio strategy. This study also offers several avenues for investigating the bondholder’s perspective on corporate diversification in more detail.

Keywords

• bondholder value
• conglomerate discount
• firm risk
• geographic diversification
• Merton model
• product diversification