To Diversify or Not to Diversify? – Questioning the Diversification Discount in Germany

Abstract

The decision to realign a company through diversification is highly relevant not only for the board and corporate development functions but also for shareholders and other stakeholders. In research and practice, the diversification of risk and return is always considered against the background of effects on stock market valuation. In this context, the question of the extent to which diversified companies are better or worse valued by the capital market has to be answered time and again. Against this background, this study examines the effects of diversification on capital market valuations using German data. Although the fact that conglomerates trade at a discount seems to be common knowledge, the results for the German market are ambiguous and outdated. Using a 2SLS approach, our study confirms the existence of a conglomerate discount, which ranges from 6.3% to 14% depending on the measure of market value. However, we find that this discount is not caused by diversification but by the factors that affect the propensity to diversify.