Does it really matter how a firm diversifies? Assets-in-place diversification versus options-based diversification

Abstract

This paper analyzes whether the valuation effect of corporate diversification depends on how this strategy is implemented. According to the real options approach, two extreme diversification patterns may be identified: one based on full exercise of available options (an assets-in-place diversification), and another aimed at seeding multiple growth options in subsequent businesses (options-based diversification). We propose an index to approximate the distance to these two diversification patterns and we explore its impact on firms’ value for a sample of U.S. firms during 1998-2010. We find that as a firm’s diversification approaches an options-based pattern, it becomes a more value-enhancing strategy.