Custodio, Claudia Perdigao Dias
(2010)
Corporate diversification: The role of industry-specific expertise and the impact of mergers and acquistions accounting.
PhD thesis, London School of Economics and Political Science.
Abstract
This thesis is organised in three chapters. The first two chapters link the industry-specific expertise of managers to the value of conglomerates and diversifying acquisitions. The third chapter explains how Mergers and Acquisitions (MandA) accounting can explain the diversification discount. The first chapter studies the cross sectional variation of conglomerate's value. I test the hypothesis that unrelated diversification destroys value because managers (CEOs) lack expertise outside the core business. I test two main implications: firms with more business activities outside the core business should have lower value and the discount should be greater for firms with more activity in unrelated-to-core secondary segments. The evidence supports both hypothesis. I test more directly if the results are linked to a lack of managerial expertise by using an industry index of managerial discretion. I find that increasing non-core business sales weight by 10% decreases firm value up to 3%, if the firm has high managerial discretion. The second chapter quantifies the value of CEO industry-specific experience, using diversifying MandA announcements. I find that industry experienced CEOs add value for their shareholders. The abnormal return is between 1.0% and 1.3% higher when the acquirer's CEO has top management experience in the target's industry. Analyzing potential mechanisms, I provide evidence that CEOs with industry experience in the target's industry negotiate better terms and that this experience is particularly valuable in environments of high informational asymmetries (1.6% - 2.9%). The results suggest that certain CEO skills are neither completely general nor firm-specific but rather specific to an industry. The third chapter shows that MandA accounting can explain the diversification discount measured with Tobin's q. The typical MandA accounting procedure inflates the book value of assets and creates a mechanical drop in the common measure of acquirers' q. Because diversified firms are more acquisitive than standalones, their q is likely to be lower, generating a spurious diversification discount. After adjusting q for goodwill by excluding it from the book value of assets, I find no significant diversification discount in most specifications. As an alternative to the goodwill correction, I use the change in the MandA accounting rules in 2001 as a natural experiment to test my main hypothesis.
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