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com

International Review of Financial Analysis 17 (2008) 747 – 766

The impact of geographic diversification

on firm performance
Young Sang Kim a , Ike Mathur b,⁎
a
Department of Economics and Finance, Northern Kentucky University, Highland Heights, KY, USA
b
Department of Finance, Southern Illinois University, Carbondale, IL, USA

Available online 3 October 2007

Abstract

This paper empirically examines the economic effects of both corporate industrial and geographic
diversifications. Using a sample of 28,050 firm-year observations from 1990 to 1998, we find that industrial
and geographic diversifications are associated with firm value decrease. Consistent with Denis et al. [Denis,
D. J., Denis, D. K., and Yost, K. (2002). Global diversification, industrial diversification, and firm value.
Journal of Finance, 57, 1951–1979], the costs of corporate diversification may outweigh the benefits of
diversification. We find that geographically diversified firms have higher R&D expenditures, advertising
expenses, operating income, ROE and ROA than industrially diversified firms. In addition, higher R&D
expenditures create value for multi-segment global firms, but not for single-segment global firms. This
result implies that there exists an interaction effect between industrial and geographic diversification. We
also examine the effects of agency cost issues, as characterized by the diversification discount, on both
industrial and geographic diversification. Consistent with the agency explanation, firms with high equity-
based compensation are associated with higher firm value than firms with low equity-based compensation.
Also, we find that firms with a higher insider ownership percentage are associated with higher excess value.
© 2007 Elsevier Inc. All rights reserved.

JEL classification: G31; G34

Keywords: Diversification discount; Industrial and geographic diversification; Agency cost

1. Introduction

In recent years, the relation between firm value and corporate diversification has become an
important empirical issue in corporate finance. Research has focused on the causes and
consequences of industrial diversification while geographic diversification has received relatively

⁎ Corresponding author. Tel.: +1 618 453 1421; fax: +1 618 453 5626.
E-mail address: imathur@cba.siu.edu (I. Mathur).

1057-5219/$ - see front matter © 2007 Elsevier Inc. All rights reserved.
doi:10.1016/j.irfa.2007.09.007
748 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766

less attention. Given the fact that a firm can diversify across different product markets or across
geographic borders or both, it is important to study the valuation effects of both industrial and
geographic diversification simultaneously.1 Industrial diversification, in general, is a value
reducing strategy. For industrial diversification, the main explanation of the diversification
discount is supported by agency theory and inefficient resource allocation. For geographic
diversification, however, empirical research has failed to provide definitive results.
This paper examines the economic effects of both corporate industrial and geographic
diversifications on firm value and contributes to the literature in several ways. First, the paper
investigates the effects of both industrial and geographic diversifications on firm value. Second, this
paper reconciles the somewhat conflicting evidence on geographic diversification. For example,
recent empirical studies by Bodnar and Ofek (1999) and Denis et al. (2002) provide conflicting
evidence on the effects of geographic diversification on firm value. Third, the relation between
industrial and geographic diversification has not been examined in the literature. Differences in firm
characteristics between the two groups might provide possible linkages between industrial and
geographic diversification. We find that geographically diversified firms have higher R&D
expenditures, advertising expenses, operating income, ROE and ROA than industrially diversified
firms. We also find a non-linear relation between geographic diversification, as measured by foreign
sales, and excess value. Finally, we examine the effects of agency cost issues, as characterized by the
diversification discount, on both industrial and geographic diversification by employing several
agency-related variables. According to the agency view (Jensen and Meckling 1976), the more
complex the corporation, the more difficult is it for shareholders to monitor management's decisions.
In general, companies adopt equity-based incentive plans to reduce this agency problem. There have
been relatively few empirical studies that examine the relation among internal corporate control,
incentive contracts and diversification simultaneously.2 In this paper, we hypothesize that firms with
higher level of incentive-based compensation or more equity ownership will cause CEOs to act in
greater alliance with shareholder interests. This implies that firms with low levels of agency
problems trade at a premium relative to firms with higher levels of agency problems. The results in
this paper are consistent with this agency explanation.
The paper proceeds as follows. The next section reviews some of the prior literature on
industrial and geographic diversification. Section 3 describes the sample selection procedures and
methodology used in this paper. Section 4 analyses the results, and Section 5 concludes the paper.

2. Literature review

Previous studies have examined the effects of diversification on firm value. For economic
explanations as to why firms diversify, a number of studies are based on the internal capital market
theory, efficient resource allocation, and synergy effect, which take a stand on the positive diversification
effect. Other studies explain the motives for firm diversification in the context of agency issues.

2.1. Theory and empirical evidence on geographic diversification

The impact of geographic diversification on firm value is ambiguous. While Bodnar, Tang, and
Weintrop (1999) find that geographic diversification adds firm value, Denis et al. (2002) find that

1
In this paper, we use the terms industrial [global] and product [geographic] diversification interchangeably.
2
A paper by Anderson et al. (2000) is the exception. This paper examines the relationship between corporate
governance and diversification. Yet, it only considers industrial diversification and does not support the agency view.
 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766 749

geographic diversification reduces firm value relative to the single-segment domestic benchmark
firms. A puzzling issue is that they find significantly different results even though both studies use
the same sample period and methodology to compute excess value. A possible reason for this
conflicting evidence may be related to the sample identification issue for geographic di-
versification and the econometric methodology, which do not correctly handle the endogeneity
problem. In addition, if global diversification affects firm value, then the level of foreign
involvement might drive the different results.3 Regardless of the possible reasons for these
conflicting results, we still do not have a clear answer to the fundamental question: “Does global
diversification create or destroy value for shareholders?” In this paper, we examine the effect of
geographic diversification on firm value while controlling for the industrial diversification effect,
to provide further evidence.
Geographic diversification can add firm value by economies of scale, location-specific ad-
vantages, and synergy effects. Geographic diversification is important because it is based on
exploiting foreign market opportunities and imperfections through internalization (Hymer 1970,
Dunning and Rugman 1985, and Rugman 1977). Through geographic diversification, firms can
bring new foreign operations within the boundaries of a firm and can readily exploit tangible
synergies such as sharing market, production, and technology related activities and intangible
synergies such as knowledge of foreign operations and expertise. Thus, geographically diversified
firms reap the monopoly rents gained through intangible assets, which are not efficient to transfer
(Errunza and Senbet 1984, and Morck and Yeung 1991). Increased operational flexibility by global
diversification reduces the risks across the markets. Geographic diversification creates value through
economies of scale and scope.
Bodnar et al. (1999) examine the impacts of geographic and industrial diversification for a
large sample of U.S. firms over the period 1984–1997 in a framework that simultaneously
controls for both types of diversification. They use foreign income and/or related taxes from
income tax disclosure to proxy for geographic diversification. The results show that geographic
diversification is associated with a significant increase in firm value, and is consistent with the
benefits of internalization theory for geographic diversification.
On the other hand, the cost side of geographic diversification is also well documented in the
literature. Multinational corporations face complex coordination problems across multiple
geographic markets to derive the benefits of economies of scale and scope. Contrary to the
synergy effect view, it is relatively easier to create market synergies within the same country
rather than different countries. International operations are also subject to certain inherent risks,
such as unexpected changes in regulatory requirements and tariffs, local political and economic
developments, difficulties in staffing and managing foreign operations, exchange controls, and
expropriation, whose costs may outweigh the benefits of global diversification.
In addition, previous studies do not provide further evidence on the determinants of global
diversification and of their valuation impacts. More importantly, the interaction effects between
geographic and industrial diversification are missing. Hitt, Hoskisson and Kim (1997) propose a
non-linear relationship between global diversification and firm performance. They show that firm
performance is initially positive but eventually becomes negative with increasing geographic
diversification. We examine this non-linear relationship between geographic diversification and
performance using the excess value measure.

3
While Denis et al. (2002) use foreign sales as a proxy for global diversification, Bodnar et al. (1999) include this
sample and also include firms that report on foreign tax. Thus, Bodnar et al. (1999) include more globally-diversified
firms in their sample. This difference might account for the different results.
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2.2. Agency perspective on corporate diversification

In contrast to the above strategic approach, the agency view argues that managers can take
private benefits such as prestige, power, and compensation from global diversification that does
not necessarily increase shareholder value (Jensen 1986, and Stulz 1990). Denis et al. (2002) find
that the valuation effects of both geographic and industrial diversification are negative. They
attribute the global diversification discount to the same factor as for industrial diversification,
namely the agency perspective. Since more diversified firms are less transparent than single
domestic firms, diversification makes it harder for board and internal control systems to prevent
sub-optimal decisions by managers or the CEOs. Geographically diversified firms are probably
even more so since foreign operations are even harder to monitor than domestic operations. Denis
et al. (2002), however, do not explicitly test for the transparency issue.4 We might expect that
geographically diversified firms would have higher information asymmetry problems and exhibit
a higher discount, compared to single-segment domestic firms. In addition, as observed in the
industrial diversification literature (e.g., Denis, Denis, and Sarin 1997), we might expect a
negative relationship between ownership and geographic diversification.
Amihud and Lev (1981) argue that managerial personal risk reduction is a motivation for
conglomerate mergers. Imperfect monitoring and contracting mechanisms induce managers to
respond to their own best interests, not necessarily maximizing shareholders' wealth. The risk-
averse manager tries to reduce personal risk to maintain his/her human capital and thus is more
likely to engage in diversification. Consistent with this argument, May (1995) finds that the more
human capital vested in the firm, the greater is the incentive to reduce firm specific risk through
diversification.
According to the free cash flow theory (Jensen 1986), when firms have enough cash flow,
managers are likely to invest in a pet project. Hyland and Diltz (2002) empirically examine
corporate diversification based on the agency view. Diversifying firms have more cash on hand,
lower research and development investment, and large compensation compared to their specialized
counterparts. The findings are consistent with the agency argument.
Another explanation of the agency view is that managerial entrenchment plays an important
role in the diversification decision. Shleifer and Vishny (1989) argue that managers' personal gains
from diversification outweigh the gains to specialization at the expense of shareholder wealth.
Denis et al. (1997) find evidence of less diversification with higher managerial equity ownership
and higher block holdings. They attribute this evidence to divergent interests of managers and
shareholders when there is low insider ownership. Aggarwal and Samwick (2003) reconsider these
two types of agency explanations (i.e., risk reduction and managerial entrenchment) to solve the
diversification puzzle in a unified equilibrium framework. They develop a contracting model in
which optimal incentive contracts mitigate manager's propensity to diversify their firms and
empirically test the relation among diversification, firm performance and incentives. They support
the managerial entrenchment explanation, but do not support the risk reduction hypothesis.
In this paper, we focus on the agency issue for both sides of diversification strategy with
several agency-related variables. There are only a few papers directly examining the agency
explanation within a unified framework, namely the interrelationship among compensation,
ownership, and corporate diversification. With incentive compensation and ownership, we test
the agency explanation for the diversification discount to overcome the omitted variable bias and

4
Thomas (2002) shows that greater diversification is not associated with increased asymmetric information. Thus, the
interpretation of Denis et al. (2002) might be problematic if this is true.
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to find a dynamic relation among variables. Including both measures of incentive and monitoring
mechanism might provide better understanding for the motives for corporate diversification. The
paper tests whether firms, even diversified firms, can increase value by providing managers more
incentives through more equity-based compensation or more equity ownership. Since managers
more aligned to shareholders may take value-enhancing decisions, it is expected that firms facing
less of an agency problem will have higher value for both single- and multi-segments.5 Thus, this
paper adds to the literature by demonstrating that the firms with greater excess value in both
the single-segment and multi-segment diversification are the ones with less potential agency
problems, resulting from the higher level of equity-based compensation or higher equity
ownership.
The paper hypothesizes that firms with the higher level of incentive-based compensation or
more insider equity ownership will cause CEOs to act in greater alliance with shareholder
interests. This implies that these firms with low levels of agency problem trade at a premium to
those firms with higher levels of agency problem. To investigate this agency issue, this paper
utilizes two variables, level of equity-based compensation (EBC) and equity ownership (OWN),
to proxy for the level of interest alignment between managers and shareholders. Using these two
measures, this paper tests the effects of agency-related cost problems on firm's valuation. Based
on 6439 firm-year observations from the Standard and Poor's ExecuComp database and
bifurcating the data into high and low EBC (OWN) based on sample median and single- and
multi-segment diversifications, companies with higher level of EBC or OWN would outperform
companies with low EBC or OWN in both single-segment and multi-segment diversifications.
These results support the contention that increases in firm value can be attributed to a decline in
the agency cost problem.

3. Sample and methodology

3.1. Sample

The initial sample of the product and geographic diversification data are obtained from the
Research Insights COMPUSTAT Industrial Segment file (C.I.S) and the Geographic Segment file
(C.G.S) over the period 1990–1998. Industrial or product diversification means that a firm reports
more than one segment in the C.I.S. files. Geographic diversification means that a firm reports
foreign sales in the C.G.S files.6 We exclude from the sample firms that have segments in the
financial industries (SIC codes 6000–6999) or the utility industries (SIC codes 4900–4999). The
sample is refined further by applying the same criteria used in Berger and Ofek (1995). We
eliminate firms from the sample with total sales less than $20 million, and when the difference
between the sum of the segment sales and total sales for the firm exceeds 1%.7 To be included in

5
Several studies show that managerial compensation structure, equity ownership, or stock options may contribute to
resolve agency problems between managers and shareholders by aligning interests of these two parties (Smith and Stulz
1985, May 1995, Chen and Ho 2000, and Datta, Iskandar-Datta and Raman 2001).
6
Bodnar et al. (1999) use the C.G.S database and tax reports to identify firms as being geographically diversified while
Denis et al. (2002) use the C.G.S database to identify global firms. We use only the C.G.S database but the number of
observations and the sample distribution do not deviate from the Bodnar et al. paper. Also, the COMPUSTAT geographic
segment files report up to ten regions and this geographic region is not reported in a consistent manner. Thus, the number
of foreign segments might be biased for interpreting foreign involvement. The level of foreign sales is a better measure of
a firm’s degree of foreign involvement.
7
This sample selection is often used in the diversification literature (see, e.g., and Denis et al. (2002)).
752 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766

the sample, firms must have data on total capital (measured as market value of equity plus book
value of debt) in the COMPUSTAT Industrial Annual files since total capital is essential data for
the excess value calculation. We also impose a restriction that there are at least five firms in the
same industry to calculate the median ratio of market capitalization to total sales for benchmark
firms. Finally, we eliminate excess values higher or lower than four times of imputed value from
benchmark firms (Berger and Ofek 1995).
The final sample includes 28,050 firm-year observations from 1990 to 1998. The sample is
divided into four categories: single-segment domestic firms (SD: 48.8% of total sample), single-
segment global firms (SG: 24.1%), multi-segment domestic firms (MD: 14.0%), and multi-
segment global firms (MG: 13.1%). The proportion of industrially diversified firms in the total
sample is 27%, and the proportion of globally diversified firms is 37%. These firm-year
observations are comparable with other previous studies in the diversification literature.
In a sub-sample to examine agency issues, we merge COMPUSTAT segment data and
Standard and Poor's ExecuComp database. Since the ExecuComp database is available only
for the period of 1992–1998 and mainly covers S&P 1500 companies, we obtain 6439 firm-
year observations in the sub-sample. Managerial compensation data (i.e., salary, bonus,
options and restricted stock) and equity ownership data are collected from the ExecuComp
database. The data are directly compiled from the companies' proxy statements and SEC
filings from 1992 to 2000. This database contains all CEO and top five executives at
each firm in the S&P 500 (SP), S&P Midcap 400 (MD), and S&P Small Cap 600 (SM)
indices.
All of the following control variables are industry adjusted relative measures, which are
calculated by the difference between each variable and that of its median value of multiplier firms.
The procedure for the computation involves the same logic as the excess value calculation. The
following relevant control variables, similar to those used in previous studies, are included. Firm
size is measured as the natural logarithm of the book value of total assets (LNTA). Profitability is
measured as EBIT (earnings before interest and taxes) divided by total sales (EBITR). Leverage is
measured as a firm's total debt to total assets (DEBTR). Growth opportunities are proxied by the
ratio of R&D expenditures to total sales (RNDR). Capital expenditure ratio is measured as capital
expenditure to firm's total sales (CAPXR). Advertising expense ratio is measured as a firm's total
advertising expenses to total sales (ADVR).

3.2. Methodology

To measure the value of industrially and geographically diversified firms, we use the excess
value measure following the modified version of Berger and Ofek (1995). We use single-segment
domestic firms (SD) as the benchmark to compute excess value and examine the effects of
industrial and geographic diversification. The measure for excess value is calculated following
Berger and Ofek (1995) with the modifications in Bodnar et al. (1999), and is defined as


EVi;t ¼ log MVi;t =Imputed valuei;t ð1Þ
X

Imputed valuei;t ¼ SSalei;t TMultiplier ð2Þ

where EVi,t, is the excess value for firm i in year t, MVi,tis the firm's market capitalization
(market value of common equity plus book value of debt) for firm i at year t. Imputed value is the
sum of segment sales (SSale) multiplied by the sales multiplier (Multiplier). The Multiplier is
 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766 753

measured as the median total market capitalization to sales for the single-segment domestic firms
in the same industry for the same year.
An alternative measure for product diversification, the Herfindahl index, is calculated for all firms
based on the distribution of the firm's sales across its various business segments. The Herfindahl
index for firm i in year t is calculated as
X
n
HERFi;t ; ¼ ðSSALE=SALEÞ2 ð3Þ
j¼1

where HERFi,t, is the sales based Herfindahl index for firm i in year t, and SSALEiis the
segment sale of the firm and SALE is the firm's total sales for all reported segments of firm i
in that year. The variable HERF equals 1 for all single-segment firms and is less than 1 for
multiple-segment firms. Smaller levels of HERF correspond to less industry focus and greater
diversification.
To examine the effect of both types of diversification on firm value, we use two sample mean
comparison statistics (t-test) and the non-parametric Wilcoxon sign rank test in four categories:
single-segment domestic, multi-segment domestic, single-segment global and multi-segment
global.
To examine the economic effects of industrial and geographic diversifications, we estimate the
following multivariate regression model with dummy and control variables:

EV ¼ a þ b1 MD Dummy þ b2 SG Dummy þ b3 MG Dummy þ b4 LNTA

þ b5 EBITR þ b6 DEBTR þ b7 CAPXR þ b8 RNDR þ b9 ADVR þ e ð4Þ
where EV is the excess value measure, MD Dummy is dummy variable equal to 1 if the firm is a
multiple-segment domestic firm and zero otherwise, SG Dummy is dummy variable equal to 1 if
the firm is a single-segment global firm and zero otherwise, MG Dummy is dummy variable equal
to 1 if the firm is a multiple-segment global firm and zero otherwise, and other firm characteristics
control variables. Control variables are industry adjusted relative measures, which are calculated
by the difference between each variable and that of its median value of multiplier firms.
To examine the synergy effect hypothesis, we re-estimate the base multivariate regression
model (Eq. (4)) with interaction dummy variables such as RND ⁎ MD, RND ⁎ SG, and RND ⁎ MG
Dummy. Based on the intangible synergy hypothesis, we expect these interaction dummy
variables to be significant and positive.
In addition, we estimate the base multivariate regression model with continuous variables such
as the Herfindahl index measure and foreign sales ratio instead of the dummy variables. These
continuous variables provide the relatedness of corporate diversification. Furthermore, we use
foreign sales ratio (FSALE) and foreign sales ratio squares (FSALESQ) to test the non-linear
relationship between geographic diversification and excess value.
We estimate the following multiple regression to examine the relation between diversification,
managerial incentive and insider ownership:

Excess Value ¼ a þ b1 MD Dummy þ b2 SG Dummy þ b3 MG Dummy

þ b4 EBC COMP þ b5 OWNER þ Control Variables þ e: ð5Þ

We include equity-based compensation variable (EBC COMP) and insider ownership variable
(OWNER) in the base regression model (Eq. (4)). We expect positive relation with equity-based
compensation and ownership variables.
754 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766

4. Empirical results

4.1. Univariate test of geographic diversification

Table 1 provides summary statistics dividing the full sample into four different categories:
single-segment domestic (SD), multi-segment domestic (MD), single-segment global (SG), and
multi-segment global (MG) for the period of 1990 to 1998. Panel A, Table 1 shows summary
statistics for diversification measures used in earlier studies. The number of firm-year observations,

Table 1
Descriptive statistics for diversifying firms 1990–1998
Single-segment, Multi-segment, Single-segment, Multi-segment, Full sample
domestic domestic global global
Number of firm-year observations 13,687 3937 6758 3668 28,050
Percentage of Firms 48.80% 14.04% 24.09% 13.07% 100.0%
Industrial segment number 1.00 2.70 1.00 3.01 1.50
Global segment number 1.00 1.00 2.66 2.83 1.64
Herfindahl index 1.000 0.602 1.000 0.529 0.883
[1.000] [0.573] [1.000] [0.510] [1.000]
Foreign sales to total sales 0.000 0.000 0.302 0.277 0.109
[0.000] [0.000] [0.265] [0.243] [0.000]
Excess value − 0.019 − 0.089 − 0.062 − 0.014 − 0.038
[0.000] [−0.098] [−0.074] [− 0.030] [− 0.022]

Firm characteristics
Total sales ($ million) 529.2 1027.6 976.0 3413.3 1083.9
[115.0] [196.0] [194.3] [814.2] [169.0]
Total assets ($ million) 437.4 1026.9 886.3 3687.7 1053.3
[89.3] [161.3] [173.0] [743.6] [138.5]
Debt to total assets 0.255 0.296 0.200 0.267 0.249
[0.228] [0.285] [0.162] [0.253] [0.225]
Capital expenditures to sales 0.074 0.068 0.066 0.067 0.071
[0.037] [0.035] [0.043] [0.045] [0.039]
R&D to sales 0.026 0.009 0.061 0.027 0.032
[0.000] [0.000] [0.027] [0.011] [0.000]
Advertising expense to sales 0.011 0.008 0.012 0.011 0.011
[0.000] [0.000] [0.000] [0.000] [0.000]
EBIT to sales 0.059 0.062 0.074 0.078 0.066
[0.061] [0.060] [0.085] [0.081] [0.069]
Return on equity (ROE) − 0.001 − 0.021 0.102 0.042 0.027
[0.096] [0.092] [0.108] [0.111] [0.099]
Return on asset (ROA) 0.019 0.021 0.024 0.031 0.022
[0.042] [0.035] [0.051] [0.043] [0.043]
Net profit Margin 0.011 0.016 0.018 0.026 0.015
[0.029] [0.026] [0.043] [0.037] [0.032]
Descriptive statistics are for a sample of 28,050 observations of four categories: single-segment domestic, multi-segment
domestic, single-segment global and multi-segment global firms. The sample contains total sales of more than $20 million
and information available from COMPUSTAT Business (CIS) and Geographic Segment databases (CGS) for the period
1990–1998. Firms are classified as multi-segment if they report more than one segment in the CIS files and firms are
classified as global if they report any foreign sales in the CGS files. Excess value is measured by a modified version of
Berger and Ofek (1995) following the Bodnar et al. (1999) methodology. In panel A, the number of firm-year observations,
percentage of firms, segment number, Herfindahl index, foreign sales ratio, and excess value are reported. Panel B provides
firm characteristics in four different categories. Sample means are reported and sample medians are reported in brackets.
 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766 755

industrial segment number, geographic segment number, Herfindahl index, the ratio of foreign sales
on total sales, and excess value are reported. The average Herfindahl index is 0.88 overall, 0.60 for
MD, and 0.53 for MG group. Since the Herfindahl index is measured by the sum of squared ratio of
firm segment sales to total sales, more diversified (focused) firms have lower (higher) Herfindahl
index values. The result shows that multi-segment global companies are more diversified than
multi-segment domestic firms. Foreign sales ratio is higher for single-segment global firms (SG)
than for multi-segment global firms (MG). By methodological design, the median value of excess
value for single-segment domestic group is zero. However, the average excess value is negative for
all four categories. This implies that the distribution of excess value is slightly skewed toward
negative. Thus, the median value of excess value is more appropriate to interpret the results.
Firm size, measured as total sales and total assets, is largest for the group of multi-segment
global firms (MG). Consistent with Lewellen's (1971) hypothesis that diversified firms have
higher debt capacity in general, the debt ratio is higher for industrially diversified firms and
highest for the group of multi-segment domestic firms (MD). However, the debt ratio is lower for
globally diversified firms compared to domestic firms and is the lowest for the group of single-
segment global firms (SG). In addition, the R&D expenditure ratio is higher for globally
diversified firms and is the highest in single-segment global firms (SG). The results support the
findings of Morck and Yeung (1991) that firms with information based assets are likely to
diversify globally (intangible synergy effect). Profitability measures such as ROE, ROA, and Net
Profit Margin are higher for diversified firms, especially globally diversified firms.
Table 2 presents univariate test statistics of excess value in the four different categories. The
difference in mean tests (t-statistics) and Wilcoxon sign rank median difference tests are reported.
The last column provides the mean and median excess value for domestic and geographically
diversified firms while the last row provides the mean and median excess value for single-segment
and industrially diversified firms. Consistent with earlier findings, we show that industrial
diversification reduces firm value by 6% compared to the benchmark firms (SD). More interestingly,
geographic diversification also reduces firm value by 5% compared to the benchmark firms (SD).

Table 2
Descriptive statistics for excess value from 1990–1998
Single-segment Multi-segment t-test Z-score Geographic all
Domestic − 0.019 − 0.089 − 6.62a −0.034
[0.000] [− 0.098] − 6.70a [− 0.007]
(13,687) (3937) (17,624)
Global − 0.062 − 0.014 3.97a −0.045
[− 0.074] [− 0.030] 3.77a [− 0.057]
(6758) (3668) (10,426)
t-test − 4.70a 5.66a −1.43
Z-score − 4.87a 5.41a −1.66c
Industrial all − 0.033 − 0.053
[− 0.008] [− 0.067] − 2.46b
(20,445) (7605) − 2.67a
The excess value measure is computed by the Bodnar et al. (1999) procedure, which is the modified version of the Berger
and Ofek (1995) measure. Descriptive statistics are for a sample of 28,050 observations of the four categories: single-
segment domestic, multi-segment domestic, single-segment global and multi-segment global firms. The sample contains
firms with total sales of more than $20 million and information available from COMPUSTAT Business (CIS) and
Geographic Segment databases (CGS) for the period 1990–1998. Panel A presents univariate test statistics of excess value
in the four categories. Difference in mean tests and non-parametric Wilcoxon sign rank median difference tests are
provided. [ ] Median, ( ) Number of firms. Superscripts a, b, c represent at the 1%, 5%, and 10% significant level.
756 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766

This finding is consistent with the findings of Denis et al. (2002) while not supporting the findings of
Bodnar et al. (1999). Multi-segment global firms (MG) are less discounted compared to the
benchmark firms and even not discounted when compared to the single-segment global firms (SG)
or multi-segment domestic firms (MD). This result suggests that there exists an interaction effect
between global and industrial diversification. Overall, the results in Table 2 are consistent with the
negative valuation theory and prior empirical findings. The costs of both industrial and geographic
diversification outweigh the benefits of diversification. Yet, these results do not control other
confounding effects to examine the pure diversification effect. Thus, we estimate the multivariate
regression model with other control variables.

4.2. Multivariate regression model

Table 3 shows the effects of both industrial and geographic diversification on firm value after
controlling for size, debt, profitability, capital expenditures, R&D expenditure, and advertising

Table 3
Multiple regression models from 1990 to 1998
Model 1 Model 2 Bodnar et al. (1999) Denis et al. (2002) Model 3 (No adj)
Intercept − 0.063 − 0.053 − 0.037 − 0.031 − 0.438
(− 15.764) (− 12.736) (−8.330) (−6.662) (− 36.279)
MD Dummy − 0.079 − 0.078 − 0.104 − 0.091
(− 10.351) (−10.253) (−10.555) (− 8.844)
SG Dummy − 0.093 − 0.093 − 0.109 − 0.118
(− 12.845) (−12.766) (−13.153) (− 13.528)
MG Dummy − 0.153 − 0.127
(−13.522) (− 11.236)
LNTA 0.051 0.055 0.062 0.061 0.060
(23.738) (24.936) (26.870) (26.495) (25.864)
EBITR 1.557 1.553 1.541 1.540 1.157
(51.990) (51.916) (51.549) (51.539) (38.669)
DEBTR − 0.094 − 0.088 − 0.087 − 0.085 − 0.017
(− 5.519) (− 5.177) (−5.107) (−5.008) (− 0.960)
CAPXR 1.422 1.411 1.401 1.402 0.689
(38.991) (38.703) (38.492) (38.542) (21.154)
RNDR 2.283 2.295 2.262 2.259 0.724
(39.144) (39.435) (38.889) (38.849) (14.616)
ADVR 0.202 0.259 0.243 0.240 0.461
(1.831) (2.354) (2.210) (2.180) (4.196)
Adjusted R-square 0.193 0.194 0.197 0.197 0.114
F-statistics 950.79 960.99 857.13 764.26 400.45
This table shows the multiple regression results. The dependent variable is excess value, calculated by capitalization
divided by imputed value. Imputed value is calculated by the industrial median value of single-segment domestic
benchmark firms. The excess value is measured by a modified version of Berger and Ofek (1995) following the procedure
of Bodnar et al. (1999). The regression model is as follows: EV = α + β1 MD Dummy + β2 SG Dummy + β3 MG Dummy + β4
LNTA + β5 EBITR + β6 DEBTR + β7 CAPXR + β8 RNDR + β9 ADVR + ɛ. The sample consists of 28,050 observations of
single- and multiple-segment industrial firms, and domestic and globally diversified firms with sales of more than $20
million. This segment information is available from COMPUSTAT Business (CIS) and Geographic Segment databases
(CGS) over the period 1990–1998. Firms are classified as multi-segment if they report more than one segment in the CIS
files and firms are classified as global if they report any foreign sales in the CGS files. MD Dummy equals 1 if a firm is
multi-segment domestic firm and 0 otherwise. SG Dummy equals 1 if a firm is a single-segment global firm and 0
otherwise. MG Dummy equal to 1 if a firm is multi-segment global firm and 0 otherwise. t-statistics are reported in
parentheses. Superscripts a, b, c represent significance at the 1%, 5%, and 10% levels, respectively.
 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766 757

expense. In the multivariate regression model, the dependent variable is the excess value
computed by the Bodnar et al. (1999) procedure. All of the control variables in the tables are
relative measures, which are calculated by the median difference from the single domestic peer
group as the same procedure in excess value. Consistent with earlier findings (Berger and Ofek
1995, Lang and Stulz 1994), the coefficient of MD Dummy (multi-segment and domestic firms) is
statistically significant and negative. More interestingly, the coefficients for the geographic
diversification dummies (SG and MG) are also negative and statistically significant at the 1%
level. These results lead to the same conclusions that are based on the univariate tests performed
in Table 2. Contrary to the positive theory in geographic diversification, both industrial and
geographic diversifications reduce firm value. The results for the control variables are generally
consistent with previous studies of diversification.
Panel A, Table 4 provides evidence of multivariate regression model that examines the synergy
effect, relatedness and foreign involvement tests. Interaction dummy variables are used in these
regression models (i.e., RND ⁎ MD Dummy, RND ⁎ SG Dummy, RND ⁎ MG Dummy). The signs
of the interaction dummy variables are positive and significant, but the coefficient of interaction
variable (SG ⁎ RND) is statistically insignificant. The results do not support the synergy effect
explanation. However, the interaction variable MG ⁎ RND is positive and statistically significant,
which supports the synergy effect hypothesis. The results imply that there exists an interaction
effect between industrial and geographic diversification (Hitt et al., 1997). Industrially diversified
companies with high intangible assets (RND) are beneficial when they are globally diversified.
Panel B, Table 4 shows that the effects of geographic and industrial diversification on firm
value are not affected by the relatedness of diversifying segments. For the relatedness of industrial
diversification, we include interaction variables HERF ⁎ MD and HERF ⁎ MG. The coefficient of
the interaction variable is positive and significant for MG. For geographic diversification, we
include interaction variables FSALE ⁎ SG and FSALE ⁎ MG. The coefficients of the interaction
variables are negative. These results show that industrial diversification with unrelated segments
reduces firm value and higher level of foreign involvement also reduces firm value. The results
support the diversification discount in both types of diversifications and are consistent with Denis
et al. (2002).
To test a non-linear relation for geographic diversification, we add FSALESQ in the regression
model. The results are shown in Panel C, Table 4. Consistent with the results in Panel B, the
foreign sales ratio is negatively related to excess value. However, this relation is not linear since
the coefficient of the square term of foreign sales ratio (FSALESQ) is positive and statistically
significant. The results are consistent with Hitt et al. (1997). The result of the U-shaped relation
between foreign involvement and firm value implies the existence of an optimal degree of global
diversification. Initial transaction costs, information asymmetry, and complexity of global
diversification in the earlier stages of diversification might explain the diversification discount.
Through geographic diversification, firms can bring new foreign operations within the boundaries
of a firm and can readily exploit tangible synergies and intangible synergies such as knowledge of
foreign operations and expertise. Thus, geographically diversified firms reap the monopoly rents
gain (Errunza and Senbet 1984, and Morck and Yeung 1991).

4.3. Agency tests: univariate results

Table 5 presents the descriptive statistics for the 6439 firm-year observations merged sample of
COMPUSTAT segment files and ExecuComp database from 1992 to 1998. The number of
observations, excess value, the proportion of cash compensation and equity compensation to total
 758
Table 4
Multiple regression models for synergy, relatedness, and non-linear tests
Panel A. Synergy effect tests
MD Dummy SG Dummy MG Dummy RND ⁎ MD RND ⁎ SG RND ⁎ MG LNTA EBITR DEBTR CAPXR RNDR ADVR Adjusted F-statistics

Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766

R-square
Model 1 − 0.104a −0.109a − 0.153a 0.061 1.540 − 0.085 1.402 2.259 0.240 0.197 764.26
(0.009) (0.008) (0.011) (0.002) (0.029) (0.017) (0.036) (0.081) (0.110)
Model 2 − 0.101a −0.110a − 0.149a 1.095a 0.152 1.205a 0.061 1.543 − 0.079 1.401 2.041 0.234 0.198 578.36
(0.009) (0.008) (0.011) (0.244) (0.118) (0.203) (0.002) (0.029) (0.017) (0.036) (0.081) (0.110)

Panel B. Relatedness tests

MD Dummy SG Dummy MG Dummy HERF ⁎ MD HERF ⁎ MG FSALE ⁎ SG FSALE ⁎ MG LNTA Control variablesd Adjusted F-statistics
R-square
Model 1 − 0.143a −0.111a − 0.230a 0.064 0.142a 0.062 − 0.198 626.45
(0.029) (0.008) (0.028) (0.046) (0.048) (0.002) − 0.198 627.30
Model 2 − 0.105a −0.070a − 0.146a −0.134a −0.032 0.062 –
(0.009) (0.013) (0.017) (0.032) (0.045) (0.002) –
Model 3 − 0.145a −0.071a − 0.224a 0.066 0.144a −0.135a −0.034 0.063 – 0.198 531.79
(0.029) (0.013) (0.031) (0.046) (0.048) (0.032) (0.046) (0.002)

Panel C. Non-linear relation tests

MD Dummy SG Dummy MG Dummy FSALE FSALE SQ LNTA EBITR DEBTR CAPXR RNDR ADVR Adjusted F-statistics
R-square
Model 1 − 0.105a − 0.080a − 0.126a − 0.101a 0.062 1.539 −0.083 1.402 2.259 0.244 0.198 689.64
(0.009) (0.011) (0.013) (0.026) (0.002) (0.029) (0.017) (0.036) (0.058) (0.110)
Model 2 − 0.106a − 0.016 − 0.065a − 0.601 0.630 a
0.064 1.536 −0.081 1.3992 2.264 0.257 0.199 632.03
(0.009) (0.015) (0.016) (0.079) (0.094) (0.002) (0.029) (0.017) (0.036) (0.058) (0.110)
This table shows the multiple regression results. The dependent variable is excess value, calculated by capitalization divided by imputed value. Imputed value is calculated by the industrial median value of
single-segment domestic benchmark firms. The excess value is measured by a modified version of Berger and Ofek (1995) following the Bodnar et al. (1999) methodology. The sample consists of 28,050
observations of single- and multiple-segment industrial firms, and domestic and globally diversified firms with sales of more than $20 million. This segment information is available from COMPUSTAT
Business (CIS) and Geographic Segment databases (CGS) over the period 1990–1998. Firms are classified as multi-segment if they report more than one segment in the CIS files and firms are classified as
global if they report any foreign sales in the CGS files. Panel A presents the synergy effect tests. The interaction variables are employed. MD Dummy equals 1 if a firm is a multi-segment domestic firm and 0
otherwise. SG Dummy equals 1 if a firm is a single-segment global firm and 0 otherwise. MG Dummy equals to 1 if a firm is a multi-segment global firm and 0 otherwise. Panel B provides test for
relatedness of diversification and foreign involvements. Panel C shows the non-linear relation of foreign involvement. Standard errors are reported in parentheses. Superscripts a, b, c represent significance
at the 1%, 5%, and 10% levels, respectively. Superscript d represents that control variables are dropped due to space condense. The results are very similar to the results of panel A.
 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766 759

Table 5
Descriptive statistics of compensation and ownership
Single-segment, Single-segment, Multi-segment, Multi-segment, Full
domestic global domestic global sample
Number of firm-year observations 2038 1923 857 1621 6439
Excess value 0.204 0.079 0.062 0.073 0.115
[0.175] [0.104] [0.026] [0.056] [0.102]
Cash based compensation 805.68 963.55 978.81 1310.75 1003.02
[599.89] [730.08] [808.90] [1111.48] [777.09]
Equity-based compensation 1132.79 1948.65 991.98 1949.65 1563.47
[274.80] [517.32] [317.06] [713.46] [449.73]
Total compensation 2095.20 3126.50 2317.10 3753.21 2850.26
[1107.00] [1500.20] [1401.09] [2322.93] [1523.39]
Percentage of cash compensation 0.611 0.558 0.615 0.531 0.576
[0.613] [0.538] [0.629] [0.527] [0.564]
Percentage of equity compensation 0.319 0.372 0.285 0.354 0.339
[0.289] [0.374] [0.251] [0.344] [0.322]
Ownership ($ thousands) 1738.33 2123.60 1531.32 1124.51 1671.69
[361.78] [197.17] [260.01] [147.11] [211.85]
Percentage of ownership 5.180 3.053 4.080 1.860 3.562
[1.167] [0.500] [0.600] [0.200] [0.500]
Total sales ($ million) 1857.89 2381.82 2608.90 5828.51 3113.91
[580.37] [723.12] [1139.46] [2349.00] [966.05]
Total asset ($ million) 1597.45 2218.09 2569.90 6334.56 3104.79
[479.81] [690.30] [974.67] [2135.60] [818.30]
Descriptive statistics are for a sample of 6439 firm-year observations of single- and multiple-segment industrial firms and
domestic and global diversified firms with sales of more than $20 million and information available from COMPUSTAT
Business (CIS) and Geographic Segment databases (CGS) over the period 1992–1998. Firms are classified as multi-
segment if they report more than one segment in the CIS files and firms are classified as global if they report any foreign
sales in the CGS files. Excess value is measured by a modified version of Berger and Ofek (1995) following the Bodnar et al.
(1999) methodology. The ExecuComp database includes S&P 500, MidCap 400, and Small Cap 600 firms. Cash based
compensation is the sum of salary and bonus. Equity-based compensation is the sum of option and restricted stock. Total
compensation is the sum of salary, bonus, options, restricted stock, and other long term incentives. Percentage of cash
compensation is the cash compensation to total compensation. Ownership is the dollar amount of CEO ownership. Total
sales are measured as firms' aggregated total sales. Sample means are reported and sample medians are reported in brackets.

compensation, and the percentage of ownership are reported in each category. The average cash
compensation in this merged sample is $1,003,021 ($777,090 in median). The group of multi-
segment global firms (MG) is the largest in cash compensation ($1.31 million in mean; $1.11
million in median) and total compensation ($3.75 million in mean; $2.32 million in median).
Then, the group of single-segment global firms (SG) and multi-segment domestic firms (MD)
are next. The group of single-segment domestic firms (SD) is the smallest in terms of the
compensation.
Geographically or industrially diversified firms have higher cash compensation and total
compensation. Based on the agency argument, where manager's private benefits are the motive for
diversification, we might observe this result. This result is consistent with Jensen and Murphy's
(1990) argument that size and compensation are positively correlated. At least to control the size
issue, we also report the proportions of cash and equity-based compensation. The average of the
proportion of equity-based compensation (EBC) is the highest for the SG group then MG, SD, and
MD. Geographically diversified firms have more equity-based compensation than domestic firms
in their compensation structure.
760 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766

The average [median] of ownership is $1.67 million [$0.21 million]. The distribution of the
amount of ownership is highly skewed. We also report the percentage of the ownership, which is
largest for SD, MD, SG, and MG in sequence. Contrary to equity-based compensation, domestic

Table 6
Univariate tests of excess value for high/low equity-based compensation
Panel A. Full sample (1992–1998)
Single-segment Multi-segment t-test Z-score Geographic all
Domestic 0.204 0.062 − 6.78a
0.162
[0.175] [0.026] − 7.12a [0.122]
(2038) (857) (2895)
Global 0.079 0.073 0.076
[0.104] [0.056] − 0.33 [0.079]
(1923) (1621) − 1.11 (3544)
t-test − 6.94a 0.48 −6.27a
Z-score − 5.88a 0.55 −5.48a
Industrial all 0.144 0.069 0.115
[0.145] [0.043] − 5.34a [0.102]
(3961) (2478) − 6.15a (6439)

Panel B. Equity-based compensation by industrial diversification

Single-segment Multi-segment t-test Z-score Geographic all
Low equity compensation 0.132 0.049 − 4.31a 0.099
[0.132] [0.020] − 5.04a [0.086]
(1965) (1291) (3256)
High equity compensation 0.154 0.091 − 3.15a 0.131
[0.153] [0.067] − 3.59a [0.121]
(1996) (1187) (3183)
t-test 1.18 1.96b 2.24b
Z-score 1.19 2.22b 2.36b

Panel C. Equity-based compensation by geographic diversification

Domestic Global t-test Z-score Geographic all
Low equity compensation 0.135 0.064 0.099
[0.097] [0.067] − 3.76a [0.086]
(1618) (1638) − 3.37a (3256)
High equity compensation 0.195 0.086 0.131
[0.156] [0.091] − 5.49a [0.121]
(1277) (1906) − 4.75a (3183)
t-test 3.07a 1.19 2.24b
Z-score 2.93a 1.31 2.36b
The excess value measure is computed by Bodnar et al. (1999) procedure. Descriptive statistics are for a sample of 6439
observations of single- and multiple-segment industrial firms and domestic and globally diversified firms with sales of
more than $20 million and information available from COMPUSTAT industrial full coverage database and geographic
segment database from 1992 to 1998. The ExecuComp database includes S&P 500, MidCap 400, and Small Cap 600
firms. Panel A shows the excess value in four categories. Panel B provides excess value of high and low equity-based
compensation group by industrial diversification. Panel C presents excess value of high and low equity-based
compensation group by geographic diversification. Difference in mean tests and non-parametric Wilcoxon sign rank
median difference tests are provided. [ ] Median, ( ) Number of firms. Superscripts a, b, c represent significance at the 1%,
5%, and 10% levels, respectively.
 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766 761

and focused firms have higher ownership percentage. This implies that large companies have a
more diversified ownership structure.
Table 6 reports the univariate results for excess value for the 6439 firm-year observations from
1992 to 1998. The excess value is computed by the Bodnar et al. (1999) procedure, which is the
modified version of the Berger and Ofek (1995) measure. In this excess value computation, we
use the benchmark of single domestic firms in all COMPUSTAT segment files. Since the

Table 7
Univariate tests of excess value for high/low equity-based compensation (recalculation)
Panel A. Full sample (1992–1998)
Single-segment Multi-segment t-test Z-core Geographic all
Domestic −0.030 0.004 1.20 −0.021
[0.000] [0.024] 1.18 [0.000]
(1706) (613) 1.46 (2319)
Global −0.193 − 0.158 0.77 −0.178
[− 0.205] [− 0.232] [− 0.215]
(1479) (1230) (2709)
t-test −8.17a − 5.16a −9.54a
Z-score −8.28a − 5.48a −10.06a
Industrial all −0.106 − 0.104 0.07 −0.105
[− 0.060] [− 0.153] 0.94 [− 0.087]
(3185) (1843) (5028)

Panel B. Excess value of industrial diversification by equity-based compensation

Single-segment Multi-segment t-test Z-core Industrial all
High equity compensation −0.095 − 0.115 − 0.80 − 0.102
(1620) (882) − 1.39 (2502)
Low equity compensation −0.117 − 0.095 − 0.89 − 0.108
(1565) (961) 0.09 (2526)
t-test −1.14 0.68 − 0.42
Z-score −0.95 0.54 − 0.33

Panel C. Excess value of global diversification by equity-based compensation

Domestic Global t-test Z-core Geographic all
High equity compensation 0.005 − 0.178 − 7.88a −0.102
(1043) (1459) − 8.14a (2502)
Low equity compensation − 0.042 − 0.177 − 5.75a −0.108
(1276) (1250) − 6.19a (2526)
t-test − 2.12b 0.08 −0.42
Z-score − 2.11b 0.01 −0.33
The excess value measure is computed by the Bodnar et al. (1999) procedure using only sub-sample single-segment
domestic firms as the benchmark instead of all COMPUSTAT firms. Descriptive statistics are for a sample of 6439
observations of single- and multiple-segment industrial firms and domestic and globally diversified firms with sales of
more than $20 million and information available from the COMPUSTAT industrial full coverage database and geographic
segment database from 1992 to 1998. The ExecuComp database includes S&P 500, MidCap 400, and Small Cap 600
firms. Panel A shows the excess value in four categories. Panel B provides excess value of high and low equity-based
compensation group by industrial diversification. Panel C presents excess value of high and low equity-based
compensation groups by geographic diversification. Difference in mean tests and non-parametric Wilcoxon sign rank
median difference tests are provided. [ ] Median, ( ) Number of firms. Superscripts a, b, c represent significance at the 1%,
5%, and 10% levels, respectively.
762 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766

ExecuComp database covers Standard & Poor's 1500 companies, the excess value for this sample
is positive for all four categories. The Standard & Poor's index committee examines five main
criteria when looking for Index candidates: trading analysis, liquidity, ownership, fundamental
analysis, market capitalization, and sector representation. Because of these selection criteria, the
firms in this merged sample are valued at a premium relative to the comparable benchmark firms
in all COMPUSTAT segment files. In Table 7, we also re-calculate the excess value in each
category by using the benchmark firms in this merged sample instead of all COMPUSTAT firms.
The results are similar to the findings of Table 6. Panel A in Table 6 shows that both industrial and
geographic diversifications are associated with reduced firm value and are statically significant at
the 1% level. For only industrially diversified firms (domestic), the average [median] difference
of excess value is 7.5% [10.2%]. For geographically diversified firms (global), the average

Table 8
Univariate tests of excess value for high/low ownership (recalculation)
Panel A. Excess value of industrial diversification by ownership (1992–1998)
Single-segment Multi-segment t-test Z-core Industrial all
High ownership − 0.031 0.059 1.82 c
− 0.011
(831) (245) 1.83 c (1076)
Low ownership − 0.132 −0.129 0.13 − 0.131
(2354) (1598) 0.73 (3952)
t-test Z-score − 4.45a − 3.90a − 5.93a
− 4.96a − 3.98a − 6.28a

Panel B. Excess value of global diversification by ownership

Domestic Global t-test Z-core Geographic all
High ownership 0.041 − 0.092 −3.47a − 0.011
(656) (420) −3.43a (1076)
Low ownership − 0.045 − 0.193 −8.07a − 0.131
(1663) (2289) −8.64a (3952)
t-test Z-score − 3.48a − 3.07a − 5.93a
− 3.83a − 3.16a − 6.28a

Panel C. Excess value of industrial diversification by ownership

SD SG MD MG All sample
High ownership −0.005 −0.078 0.232 −0.128 −0.011
(529) (302) (127) (118) (1076)
Low ownership −0.041 −0.223 −0.056 −0.162 −0.131
(1177) (1177) (486) (1112) (3952)
t-test Z-score 1.35 −3.73a −4.40a −0.54 −5.93a
2.11b −3.85a −4.54a −0.27 −6.28a
The excess value measure is computed by the Bodnar et al. (1999) procedure using the sub-sample of single-segment and
domestic firms as the benchmark instead of all COMPUSTAT firms. Descriptive statistics are for a sample of 6439
observations of single- and multiple-segment industrial firms and domestic and globally diversified firms with sales of
more than $20 million and information available from the COMPUSTAT industrial full coverage database and geographic
segment database from 1982 to 1998. Panel A shows the excess value of industrial diversification by high/low ownership.
Panel B provides excess value of global diversification by high/low ownership. Panel C presents excess value of the four
categories by high/low ownership. Difference in mean tests and non-parametric Wilcoxon sign rank median difference
tests are provided. [ ] Median, ( ) Number of firms. Superscripts a, b, c represent significance at the 1%, 5%, and 10%
levels, respectively.
 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766 763

[median] difference of excess value is 8.6% [4.3%] and statistically significant at the 1% level.
Overall, this result is consistent with the findings of Denis et al. (2002) and with Table 2 for the
full sample results. Both industrial and geographic diversifications reduce firm value.
Panel B shows univariate tests of excess value in industrial diversification by bifurcating the
sample by high and low equity-based compensation. According to the agency view, managers
with higher equity-based compensation have the incentive to increase firm value and reduce
agency costs. Thus, firms with high equity-based compensation have higher excess value than

Table 9
Multiple regression models: compensation and ownership
Model 1 Model 2 Model 3 Model 4 Model 5
a a a a
Intercept 0.058 0.077 0.104 0.089 0.060 a
(0.011) (0.012) (0.013) (0.014) (0.016)
IND Dummy − 0.042 a − 0.063 a − 0.128 a − 0.128 a −0.125 a
(0.018) (0.019) (0.021) (0.021) (0.022)
GLOBAL Dummy − 0.060 a − 0.129 a − 0.131 a −0.122 a
(0.014) (0.017) (0.017) (0.017)
BOTH Dummy −0.147 a −0.147 a −0.136 a
(0.019) (0.020) (0.020)
Equity-based compensation 0.048b 0.069 a
(0.022) (0.023)
Ownership percentage 0.004 a
(0.001)
LNTA 0.001 0.001 0.019 a 0.019 a 0.019 a
(0.004) (0.004) (0.005) (0.005) (0.005)
EBITR 1.488 a 1.492 a 1.471 a 1.466 a 1.511 a
(0.056) (0.057) (0.056) (0.056) (0.058)
DEBTR −0.179 a −0.172 a −0.167 a −0.164 a −0.147 a
(0.037) (0.037) (0.037) (0.037) (0.039)
CAPXR 1.133 a 1.131a` 1.092a 1.090a 1.053a
(0.062) (0.062) (0.062) (0.062) (0.062)
RNDR 1.924 a 1.915a 1.871a 1.849a 1.903a
(0.087) (0.087) (0.087) (0.087) (0.087)
ADVR 0.666 a 0.689a 0.717a 0.692a 0.679a
(0.219) (0.219) (0.218) (0.218) (0.219)
Adjusted R-square 0.158 0.160 0.167 0.168 0.173
F-statistics 172.39 153.43 143.56 128.45 119.67
This table presents the multiple regression results. The dependent variable is excess value, calculated by capitalization
divided by imputed value. Imputed value is calculated by the industrial median value of single-segment domestic
benchmark firms. The excess value is measured by a modified version of Berger and Ofek (1995) following the procedure
of Bodnar et al. (1999). The regression model is as follows: EV = α + b1 IND Dummy + b2 GLOBAL Dummy + b3 BOTH
Dummy + β5 EBC + β6 OWN + β7 Control Variables + ɛ. The sample consists of 28,050 observations of single- and
multiple-segment industrial firms, and domestic, globally diversified firms with sales of more than $20 million. This
segment information is available from COMPUSTAT Business (CIS) and Geographic Segment databases (CGS) over the
period 1982–1998. A firm is classified as multi-segment if it reports more than one segment in the CIS files and a firm is
classified as global if it reports any foreign sales in the CGS files. IND Dummy equals 1 if a firm is a multi-segment firm
and 0 otherwise. GLOBAL Dummy equals 1 if a firm is a global firm and 0 otherwise. BOTH Dummy equals 1 if a firm is
a multi-segment and global firm and 0 otherwise. Equity-based compensation is measured as the proportion of equity-
based compensation (options + restricted stock) to the total compensation. Ownership percentage is measured as the
percentage of equity ownership by the CEO. Standard deviations are reported in parentheses. Superscripts a, b, c represent
significance at the 1%, 5%, and 10% levels, respectively.
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firms with low equity-based compensation. Consistent with this incentive hypothesis, the average
difference of industrially diversified firms is 3.2% and is statistically significant at the 5% level.
Panel C in Table 6 reports the univariate tests of excess value in the geographic diversification
sub-sample. The result is similar to the findings in Panel B. Regardless of the different types of
diversifications, firms with high equity-based compensation are associated with higher firm value
than firms with low equity-based compensation.
In order to examine the relation with ownership and firm value in diversified firms, Table 8
provides statistics for the sample split between high and low percentage of ownership for industrial
and geographic diversification. Panel A and Panel B present univariate statistics for industrially and
geographically diversified firms, respectively. The average difference between high and low
ownership firms is 12.0%. The group of low ownership firms is associated with lower firm value in
both single and diversified firms. The result supports the hypothesis that firms with higher ownership
percentage are associated with higher excess value.

4.4. Agency tests: multivariate regression models

Table 9 presents the results of five specifications of multivariate regression models that
relate excess value to managerial incentive, ownership, and control variables. The dependent
variable, excess value, is calculated following Berger and Ofek (1995) with the modifications
in Bodnar et al. (1999). In Table 9, the coefficients of major variables of interest, EBC
and OWN, are positive and statistically significant at the 1% level. This result is consistent
with the agency explanation and findings of univariate tests. Also, consistent with earlier
diversification literature, the coefficients of the diversification measures are negative and
statistically significant at the 1% level in all specifications. These results confirm the existence
of a diversification discount in industrial and geographic diversification after controlling other
variables.
The results for the control variables are generally consistent with previous studies in
diversification. We find a statistically significant relation between excess value and LNTA,
EBITR, DEBTR, CAPXR, RNDR, and ADVR.

5. Conclusions

This paper empirically investigates the effects of both industrial and geographic diversifica-
tions on firm value. Using a sample of 28,050 firm-year observations from 1990 to 1998, we find
that both industrial and geographic diversifications are associated with firm value decrease. The
results are consistent with Denis et al. (2002). The costs of corporate diversification may
outweigh the benefits of diversification. Differences in firm characteristics might provide possible
linkages between industrial and geographic diversification. We find that geographically
diversified firms have higher R&D expenditures, advertising expenses, operating income, ROE
and ROA than those of industrially diversified firms. In addition, higher R&D expenditures create
value for multi-segment global firms [MG], but not for single-segment global firms. This result
implies that there exists an interaction effect between industrial and geographic diversification.
The relatedness of segments (Herfindahl index) and foreign involvement (Foreign sales to total
sales) also play a role in firm value. Unrelated segment diversification and higher foreign
involvement reduce firm value.
We examine the effects of agency cost issues, as characterized by the diversification discount,
on both industrial and geographic diversification by employing several agency-related variables.
 Y.S. Kim, I. Mathur / International Review of Financial Analysis 17 (2008) 747–766 765

Consistent with the agency explanation, firms with high equity-based compensation are
associated with higher firm value than firms with low equity-based compensation. Also, we find
that firms with a higher insider stock ownership percentage are associated with higher excess
value.

Acknowledgments

We thank Dave Davidson, Jim Musumeci, Mark Peterson, Subhash Sharma, a referee, guest
editor Lloyd Blenman, seminar participants at Southern Illinois University at Carbondale,
participants at the 2005 Financial Management Association, and the 2006 Midwest Finance
Association annual meeting for comments that have helped improve the quality of the paper.

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