The Effect of Firm Diversification on Capital Structure: Evidence from Spanish Firms

17 Pages Posted: 7 Dec 2000

Abstract

The objective of this study is to analyze the potential relationship between capital structure and the diversification strategy of the firm for a sample of 480 Spanish manufacturing firms during the period 1991-1994. The results show a negative and statistically significant relation between firm debt level and the degree of firm diversification. This empirical evidence is consistent with the disciplinary effect of debt on managerial decisions, and the role of debt as a governance device. The increased monitoring of firm decisions by debtholders implies a low probability that managers follow value-decreasing strategies, such as unrelated diversification, that could not be justified from a shareholder viewpoint. This negative relation between debt level and diversification strategy holds true when controlling for firm size, growth opportunities, business risk, or the level of intangible assets. However, the statistical significance of this relation disappears with an additional control for the profitability of firms.

Keywords: Capital Structure, Diversification Strategy, Coinsurance Effect, Agency Costs, Transaction Costs.

JEL Classification: G32, G34, L60

Suggested Citation

Menéndez Alonso, Eduardo José, The Effect of Firm Diversification on Capital Structure: Evidence from Spanish Firms. Available at SSRN: https://ssrn.com/abstract=250230 or http://dx.doi.org/10.2139/ssrn.250230

Eduardo José Menéndez Alonso (Contact Author)

Universidad de Oviedo - Business Administration ( email )

Avenida del Cristo s/n
33071-Oviedo
Asturias
Spain

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