Three essays in corporate diversification

Publication Type:
Thesis
Issue Date:
2012
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NO FULL TEXT AVAILABLE. This thesis contains 3rd party copyright material. ----- This thesis investigates the implications of corporate diversification from three perspectives: (i) managerial incentives to engage in earnings management; (ii) forecasting activities of financial analysts; and (iii) managerial internal capital allocation. As firms often use accruals to reduce earnings volatility, in Chapter 2 I hypothesise that managers of diversified firms would have less incentive to engage in accruals management than those of focused firms because diversified firms experience a reduction in earnings volatility by virtue of the diversification of risk. My results show that diversification plays a significant role in deterring earnings management. I document that imperfect divisional cash flow correlations result in a reduction in a firm's cash flow volatility, and that this seems to lessen substantially a diversified firm's need for accruals management. In Chapter 3, I study the effect of corporate diversification from the perspective of financial analysts. Existing studies argue that earnings variability increases the difficulty of analysts ' forecasting tasks. As such, I argue that the level of forecasting difficulty is most likely lower among diversified firms because diversification leads to a reduction in earnings variability. I show that analysts following diversified firms tend to produce more accurate forecasts of earnings, and that these forecasts tend to be also less dispersed relative to analysts' consensus estimates. Further, I demonstrate that analyst forecasts for focused firms are associated with a greater level of optimism bias. Finally, I indicate that the introduction of Regulation Fair Disclosure has significantly reduced the discrepancy in optimism bias observed across different levels of diversification. In Chapter 4, I provide evidence that effective monitoring could promote managerial risk-taking in internal capital allocation activities. Explicitly, I show that risk-averse managers, without proper incentives, may not provide funds to a segment if that segment has too high risk irrespective of its profitability. I illustrate that incentive contracts that link the wealth of managers to that of shareholders, and enhanced shareholder protection, are likely to discipline managers to work in the best interests of investors. I find that managers provided with compensation packages characterised by greater sensitivity to stock price tend to allocate greater capital to high-risk segments. Also, CEOs in firms with stronger shareholder rights as measured by the number of anti-takeover provisions in the firm's charter are more likely to implement risk-taking policies by increasing the level of investment in a riskier business segment.
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