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Optimal Diversification: Reconciling Theory and Evidence

Joao Gomes and Dmitry Livdan
The Journal of Finance
Vol. 59, No. 2 (Apr., 2004), pp. 507-535
Published by: Wiley for the American Finance Association
Stable URL: http://www.jstor.org/stable/3694906
Page Count: 29
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Optimal Diversification: Reconciling Theory and Evidence
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Abstract

In this paper we show that the main empirical findings about firm diversification and performance are consistent with the maximization of shareholder value. In our model, diversification allows a firm to explore better productive opportunities while taking advantage of synergies. By explicitly linking the diversification strategies of the firm to differences in size and productivity, our model provides a natural laboratory to investigate several aspects of the relationship between diversification and performance. Specifically, we show that our model can rationalize the evidence on the diversification discount (Lang and Stulz (1994)) and the documented relation between diversification and productivity (Schoar (2002)).

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