Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 294: Why Agency Costs Explain Diversification Discounts

Henrik Cronqvist (), Peter Högfeldt () and Mattias Nilsson ()
Additional contact information
Henrik Cronqvist: Graduate School of Business, Postal: University of Chicago
Peter Högfeldt: Department of Finance, Stockholm School of Economics, Postal: Box 6501, SE-113 83 Stockholm, Sweden
Mattias Nilsson: Department of Finance, Stockholm School of Economics, Postal: Box 6501, SE-113 83 Stockholm, Sweden

Abstract: We study diversification within the real estate industry because of its relative transparency: portfolio management of assets with well-defined market prices. Diversification is over property types and geographical regions. The major cause of the diversification discount is not diversification per se but anticipated costs due to rent dissipation in future diversifying acquisitions. Firms expected to pursue non-focusing strategies do indeed diversify more, are valued ex ante at a 20% discount over firms anticipated to follow a focusing strategy, are predominantly privately controlled and extensively using dual-class shares. The ex ante diversification discount is, therefore, a measure of agency costs.

Keywords: Diversification; Diversifying strategy; Ex ante discounts; Rent dissipation; Agency costs; Private control

JEL-codes: G30; G31; G32

52 pages, First version: January 21, 1999. Revised: September 27, 2000. Earlier revisions: January 2, 2000, June 14, 2000, September 27, 2000.

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