Capital Market Conditions and the Value of Corporate Diversification for Japanese Firms

This study investigates the value of corporate diversification in Japanese firms with particular attention to its dynamics. Our analysis, based on a panel of listed nonfinancial firms, indicates that the value of diversification increases substantially when external capital is costlier or more difficult to access. Moreover, this tendency is more pronounced for firms in which divisional cash flows are less positively correlated. This pattern implies that coinsurance is instrumental to the observed association between the value of diversification and capital market conditions. We also find that this association is stronger for firms with higher bankruptcy risk, which is consistent with the notion that the financing advantages of diversified firms improve their ability to fulfill contractual obligations. These results suggest that the value of corporate diversification fluctuates because macroeconomic shocks change the relative value of the internal and external capital markets.