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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
VI. Excess Value and Firm Diversification
Our empirical findings in Section V confirm the documented inverse relation between diversification and managerial ownership. Various governance mechanisms, however, may be used as complements or substitutes for each other (Agrawal and Knoeber, 1996). Our previous analysis provides some evidence that diversified firms may use alternative governance mechanisms, namely outside directors, to compensate for low ownership. To provide further evidence on the role that alternative governance characteristics might play in diversified firms, we examine the relationship between firm value and governance structure. If agency costs resulting from failures in internal governance are more pronounced in diversified firms, we should detect systematic differences between firm value and corporate governance across diversified and focused firms. Although we cannot assess causation based on our results given that governance structure is determined endogeneously, our findings provide some evidence about what aspects of corporate governance are related to firm performance in single- and multi-segment firms.
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Table VIII presents Fama-MacBeth cross-sectional regressions of revenue-based excess value on our measures of corporate governance and control variables. Governance characteristics include the level of CEO ownership, the fraction of equity-based pay, and board structure. Board structure is measured both as the fraction of outsiders on the board, and as a dummy variable equal to one if the fraction of outsiders is greater than 50%.
When we do not include governance variables, Model 1 demonstrates that, on average, multisegment firms have an imputed value approximately 14% (p-value=0.00) greater than their actual market value, which is similar to Berger and Ofek (1995). The effects of governance on firm value are captured in Models 2 and 3. In both single- and multi-segment firms, we find that equity ownership of the CEO is unrelated to excess value. [12] Low ownership does not appear to explain the valuation discount from diversification. We find that in single-segment firms, the fraction of equity-based pay is positively related to excess-value (p-value=0.00). Mehran (1996) finds a positive relation between equity based pay and firm value but he does not distinguish between single- and multi-segment firms. The overall effect of equity based pay in diversified firms is measured by the sum of the coefficients on the two equity-based pay variables and is not statistically different from zero (p-value = 0.91). Our findings indicate that e quity-based pay is unrelated to excess value in multi-segment firms. The negative coefficient on the interaction term for equity-based pay and the fact that there is no reliable relation between pay and excess value for diversified firms is consistent with the view that large amounts of performance based pay may not be optimal in a diversified firm. Another possible interpretation, which is consistent with our findings in Section VI, is that firms with large valuation discounts impose more equity-based pay on the manager to provide incentives to restructure the firm.
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