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The Diversification Discount Puzzle: Empirical Evidence for a Transactions Cost Resolution

Raj Aggarwal and Shelly Zhao

Abstract

Prior literature on the diversification discount and the relative efficiency of internal versus external capital markets provides decidedly mixed results. We argue that transactions cost economics are useful in understanding this puzzle. According to transactions cost economics, diversified firms should outperform single-segment firms in industries with higher external transaction costs (e.g., emergent industries). Similarly, single-segment firms should outperform diversified firms in industries with low external transactions costs and high agency and other internal costs (e.g., some mature industries). This paper provides empirical evidence supporting these contentions.

JEL codes: G14, G31, L22
Key words: Diversification, transaction cost economics, internal markets


Last updated 28 August 2014 by IIIS (Email).