The Diversification Discount: It's All Cash Flows

51 Pages Posted: 7 Sep 2004

See all articles by Bill B. Francis

Bill B. Francis

University of South Florida - College of Business Administration

Delroy M. Hunter

University of South Florida

Iftekhar Hasan

Fordham University ; Bank of Finland; University of Sydney

Date Written: September 1, 2004

Abstract

We examine why some diversified firms trade at a discount and others at a premium. Specifically, we examine if the value premium (discount) of premium (discount) diversified firms can be explained by lower (higher) risk exposures and, hence, expected returns, relative to a portfolio of matching focused firms. Using a four-factor conditional asset-pricing model, we find that premium firms have higher expected returns while discount firms have lower expected returns than their corresponding portfolios of matching focused firms. This indicates that the value premium (discount) of premium (discount) diversified firms is due entirely to higher (lower) expected cash flows. In addition, we find that the average diversified firm has significantly lower mean risk exposures and expected returns than a portfolio of matching focused firms. This means that its value discount is due entirely to lower expected cash flows. This is in contrast to Lamont and Polk (2001) who attribute just over 50% of the variation in excess values to future cash flows. Our results also indicate that the value discount of the average diversified firm can be attributed entirely to the expected cash-flow dissipation of discount diversified firms.

Keywords: Diversification discount, diversified firms, premium firms, discount firms, expected returns, conditional asset pricing model

JEL Classification: G12, G34

Suggested Citation

Francis, Bill B. and Hunter, Delroy M. and Hasan, Iftekhar, The Diversification Discount: It's All Cash Flows (September 1, 2004). Available at SSRN: https://ssrn.com/abstract=586507 or http://dx.doi.org/10.2139/ssrn.586507

Bill B. Francis (Contact Author)

University of South Florida - College of Business Administration ( email )

4202 E. Fowler Avenue, BSN 3403
Dept. of Finance
Tampa, FL 33620-5500
United States
813-974-6300 (Phone)
813-974-3030 (Fax)

HOME PAGE: http://www.coba.usf.edu/departments/finance/facult

Delroy M. Hunter

University of South Florida ( email )

Dept of Finance, Muma College of Business
4202 E. Fowler Ave, BSN3403
Tampa, FL 33620
United States
(813) 843-2085 (Phone)
(813) 974-3084 (Fax)

HOME PAGE: http://www.usf.edu/business/contacts/hunter-delroy.aspx

Iftekhar Hasan

Fordham University ( email )

45 COLUMBUS AVENUE
GBA-5TH FLOOR
NEW YORK, NY 10023
United States

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

University of Sydney ( email )

P.O. Box H58
Sydney, NSW 2006
Australia

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