Corporate Governance and Firm Diversification

Financial Management (Financial Management Association), Spring, 2000 by Ronald C. Anderson, Thomas W. Bates, John M. Bizjak, Michael L. Lemmon

These summary statistics indicate that the sample employed in this study is comparable to others used in prior research on diversification. For example, the average number of business segments in our sample is comparable to the averages reported by Denis, Denis, and Sarin (1997), Rose and Shepard (1997), and Lang and Stulz (1994) who report 2.41, 2.61, and 2.54 segments, respectively. In addition, the percent of firms reporting more than one business segment in our sample is similar to the 67% reported by Denis et al. and the 60% reported by Rose and Shepard. Other firm and ownership characteristics are similarly comparable to those reported in other studies in this area. For example, the mean ownership of officers and directors in Denis et al. is 11.7%, and the average CEO tenure in Rose and Shepard is 11.2 years.

III. The Characteristics of Focused and Diversified Firms

Tables II and III present univariate comparisons of financial and governance characteristics between single- and multi-segment companies. Because observations within a firm are unlikely to be independent, the statistical significance is overstated. The results are essentially unchanged, however, if we treat the time series average of a variable within each firm as a single observation. We address this issue in the multivariate analysis that follows.

Table II provides a comparison of financial characteristics between single and multi-segment firms. Multi-segment firms tend to be larger, carry more debt and spend less on R&D. Consistent with the findings of Berger and Ofek (1995), we also find that diversified companies have significantly lower imputed excess value as compared to single-segment firms.

In Table III, we report univariate comparisons of governance characteristics between single and multi-segment firms. Similar to Servaes (1996) and Denis, Denis, and Sarin (1997), our results suggest that CEO ownership and ownership of all officers and directors is significantly lower in multi-segment firms. The average percentage ownership of all officers and directors of multi-segment firms is 6.6% less than the average holdings in single-segment firms. The table also shows that the average holdings of unaffiliated blockholders are 1% lower in diversified firms. The median CEO in a diversified firm earns $110,000 more in salary and bonus and $400,000 more in stock options than the median CEO in a focused firm. [6] Additionally, equity-based pay makes up a larger fraction of total CEO compensation in diversified firms. We find that managerial turnover is significantly higher in multi-segment firms. Specifically, the frequency of CEO turnover is 7.8% in multi-segment firms as compared to 5.8% in single-segmen t firms (p-value of 0.10). On average, multi-segment firms have slightly larger boards (by about one director), but have 6% more outside directors and 5% fewer inside directors than focused firms (p-values=0.00).

The univariate analysis highlights differences that exist between focused and diversified companies. While ownership differences provide some evidence of managerial entrenchment, differences in board composition, turnover, and equity-based compensation indicate that diversified companies may substitute other governance mechanisms for low ownership.