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Corporate Governance and Firm Diversification
Financial Management (Financial Management Association), Spring, 2000 by Ronald C. Anderson, Thomas W. Bates, John M. Bizjak, Michael L. Lemmon
Several of the firms in our sample permanently alter their level of diversification over the sample period; accordingly, we examine two different measures of change in focus. First, we classify a change in focus as any permanent revision in the number of reported business segments (Panel A of Table VII). According to this taxonomy, 54 firms experienced a sustained decrease in corporate diversification over the sample period, while 31 firms increased their level of diversification. Second, we consider changes in focus that result in a permanent movement between the reporting of single and multiple segments (Panel B of Table VII). [10] For example, under this classification scheme a firm would increase its level of diversification if it went from reporting one segment to more than one segment and would decrease diversification if it went from reporting more than one segment to reporting only one segment. According to this taxonomy, 12 firms experienced a sustained decrease in corporate diversification over the sample period, while 10 firms increased their level of diversification.
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Table VII reports the results of difference in means tests performed on compensation and governance variables between the firms that either increased or decreased focus over the sample period, and firms which did not. Variables for each firm that changed focus are recorded in the year prior to the first change in the number of reported segments. These observations are compared to the sample of firms that did not change focus over the sample period. The comparison group in Panel B includes only single-segment firms.
For both Panels A and B, the third column indicates that the governance characteristics of firms that increase diversification are remarkably similar to those with no change. The one notable exception is equity-based pay. In Panel A, firms that increase their levels of diversification have slightly more equity-based pay compared to firms that did not change. These results contrast with the predictions of the agency cost hypothesis and suggest that differences in governance structures explain little about the decision to diversify. Consistent with findings by Lang and Stulz (1994), firms that choose to diversify also have lower excess-values in the year prior to diversification than firms that do not, however the difference is not significant.
In the first column of both panels of Table VII, our results indicate that CEO and insider ownership are lowest in firms that reduce their level of diversification. In Panel A, average CEO ownership in firms that refocused is 2.3%, significantly lower than that in firms that had no change in focus. While ownership is lower in firms that refocus, focusing firms also tend to utilize a higher proportion of equity-based compensation compared to firms that do not change focus over the sample period. These findings are consistent with the notion that performance-based compensation can provide incentives to low ownership CEO's to reverse value decreasing diversification strategies. [11]
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