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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
Previous versions of this paper were circulated under the title "Pay-for-Performance and Firm Diversification." We thank Hank Bessembinder, Jeff Coles, Mike Hertzel, Kenneth Lehn, and seminar participants at Arizona State University and the 1998 Financial Management Association International meeting in Chicago for helpful comments. We also thank two anonymous referees and the Editors for their help in substantially improving the paper.
(*.) Ronald C. Anderson is an Assistant Professor of Finance at American university. Thomas W. Bates is an Assistant Professor of Finance at the University of Western Ontario. John M. Bizjak is an Assistant Professor of Finance at Portland State University. Michael L. Lemmon is an Assistant Professor of Finance at Arizona State University.
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(1.) We refer the reader to Williamson (1970), Lewellen (1971), Stulz (1990), and Stein (1997) for discussions regarding the potential benefits of diversfication. Evidence that diversification did not decrease value in the 1960s is presented by Hubbard and Palia (1999).
(2.) These costs might include transactions costs associated with breaking and rewriting implicit and explicit contracts with the firm's various claimants. For example, in a refocusing divestiture, debtholders could see the value of their collateral significantly reduced, and employees could lose a large portion of their firm-specific human capital.
(3.) While our sampling minimizes the possible effects of survival, an additional source of bias is present if single-segment firms would exit a random sample at a different rate than multi-segment firms.
(4.) We repeated our subsequent analyses using only the years for which we had governance data. The conclusions were unchanged.
(5.) To ensure the robustness of our results, we repeated our analyses using a dummy variable equal to one only if the firm reported operations in more than one two-digit SIC code. This proxy attempts to measure only unrelated diversification. The results using this alternative measure of diversification policy (results not reported) were qualitatively similar to those presented here.
(6.) Because of problems with outliers, when comparing differences in compensation structure we use medians instead of means. For a more thorough discussion of why medians are more appropriate when measuring compensation characteristics see Jensen and Murphy (1990).
(7.) Although not reported, we also document that the level of compensation is approximately 9% higher in diversified firms than in focused firms. This finding is similar to the evidence presented in Rose and Shepard (1997), who suggest that these higher levels of pay are consistent with the view that operating a diversified company requires greater managerial ability.
(8.) Jensen and Murphy (1990), using a panel of 73 firms from 1969 through 1983, find that total CEO compensation changes by $0.30 per $1000 change in shareholder wealth. Our estimate is approximately four times larger than their figures. We attribute this difference to a documented increase in the prevalence of option-based CEO compensation in the 1990s (Hall and Liebman, 1998).
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