Value, Survival, and the Evolution of Firm Organizational Structure

We examine corporate product diversification as a dynamic process. Consistent with prior research, we find that the average diversification discount is about 8% when using the standard valuemultiple approach. However we find that a significantportion of the diversification discount arises from benchmark comparisons of value ratios of mature firms with those of very young firms that are more likely to have high value multiples. The magnitude of the diversification discount falls by 15% to 30% when we control for firm age. We also show that diversification reduces the mortality rate offirms, and we provide evidence that mature firms pursue diversification strategies partly as a means to exit stagnant business segments for industries that are more highly valued. Since the 1990s, the relation between corporate product diversification and firm value has received considerable attention. Researchers have shown that firms diversified along product lines trade at a discount on average, compared to focused firms. Consequently, many researchers and practitioners argue that firms should focus their business lines, but a large number of firms remain diversified and many others continue to diversify.' Firms typically begin as focused entities and, as they age, they often expand their business scope, in many cases as a survival response to market pressures. In addition to its impact on the likelihood of diversification, firm age is also likely to affect the measured value of diversification. In the standard Berger and Ofek (1995) imputed-value approach, a weighted average of pure-play market multiples are used to calculate the implied value of diversified firms. However, these multiples may be affected by factors other than the firm's organizational structure. Firm age, for example, may be a useful proxy for growth opportunities and other factors that are likely to have a profound effect on the market multiples of individual firms. Therefore, the estimated value of diversification is likely to vary over time with changes in the average age of publicly traded firms. Indeed, Fama and French (2004) demonstrate that the percentage of new firms and the characteristics of new lists have changed substantially since 1973. In this paper, we examine the influence that firm age has on organizational structure and on the observed average diversification discount, and the influence of organizational structure on firm survival. We demonstrate that 15% to 30% of the estimated diversification discount is a firm age discount and that diversified firms are less likely than focused firms to go out of business.