Corporate Diversification and Long-run Performance of SEO Firms --Evidence from Taiwan--

1. Corporate Diversification and Long-run Performance of SEO Firms--Evidence from Taiwan-- Jeng-Ren Chiou Ming-Yuan Li Ting-Kai Chou Chao-Ya Wan

2. Outline 1. Introduction 2. Hypothesis Development 3. Data and Empirical Design 4. Empirical Results Analysis 5. Conclusions

3. Introduction • A large and growing literature examines the consequences of corporate diversification. • diversified firms sell at a discount relative to focused firms. • stock prices tend to fall when firms announce focus-decreasing corporate actions. • The prior evidence suggests that the costs of corporate diversification exceed the benefits.

4. Introduction • Recent papers try to identify some of the costs of diversification by examining the investment patterns of diversified firms. • Scharfstein (1998) • Rajan, Servaes and Zingales (2000) • Cross-subsidization phenomenon • A conglomerate firm always invest more in weak division than their stand-alone industry peers.  diversified firms would invest more in relatively poorer projects than focused firms

5. Introduction • There is little empirical work that directly identifies the benefits of diversification. • Lewellen (1971) - coinsurance effects increase a diversified firms’ debt capacity relative to the aggregate debt capacity of its individual divisions as stand-alone firms. • Williamson (1975) , Stein (1997), Lamont (1997) and Shin and Stulz (1998) - internal capital market and efficiently allocating cash across divisions.

6. Research Objective • We try to provide evidence on the potential benefits associated with corporate diversification • examine the effect of diversification on subsequent performance following the equity issues. • The direction of relationship between diversification and post-SEO performance is unclear.

7. Hypotheses Development • Internal capital market hypothesis • In diversified firms, profitable product lines can allocate much needed capital to negative cash flow businesses. • There may also be positive synergies between the lines of businesses of the issuing firms. • Under the assumptions of efficient internal capital markets and/or synergies, we would expect a positive relationship between diversification and post-SEO long run performance.

8. Hypotheses Development • Resource misallocation hypothesis • Berger and Ofek (1995) provide an exposition on how corporate diversification can decrease firm value. • There may be a higher propensity for the misallocation of capital across business segments through inefficient cross-subsidization in a diversified firm. • Rajan, Servaes, and Zingales (2000) • Scharfstein and Stein (2000). • We expect a negative relationship between diversification and post-SEO long run performance.

9. Data • Seasoned equity offerings on the Taiwan Securities Exchange over 1995-2002. • exclude financial companies and firms without complete data. • A total of 386 equity issues remain after our selection criteria. Sample Selection

10. Sample Distribution by Year • Most of the offerings occur in the 1996-1998 periods. • Due to the economic recession in Taiwan capital markets, only five offerings conducted in 2001.

11. Sample Distribution by Industry • The SEO sample varies by industry from 143 offerings in the electronics classification to 1 offering from automobile industry.

12. Methodology • Buy-and-Hold Abnormal Returns (BHAR) • BHAR represents the monthly compounding return for issuing firm from a buy and hold strategy, adjusted by the holding period return on the benchmark during the corresponding period. • size-matched portfolio • B/M-matched portfolio • size-and-B/M-matched portfolio

13. Methodology • Measure of Diversification (1) • Herfindahl index (HINDEX) - reflects the degree to which the sales of a firm are concentrated within its divisions. • The variable HINDEX equals 1 for all single-segment firms and is less than 1 for multiple-segment firms. • Smaller levels of HINDEX correspond to less industry focus and greater diversification.

14. Methodology • Measure of Diversification (2) • Diversification Dummy (DIV) - identify whether a firm has multiple segments or not. • The DIV equals 1 if the firm has multiple segments, and 0 otherwise.

15. Empirical Results-Summary Statistics of SEOs- We find that SEO issuers, on average, have two segments. The mean Herfindahl index is 0.781. The mean gross proceeds are 436.03 million NT dollars or US$ 13.03 million. Compared with other developed capital market like the U.S., and Japan, gross proceed for Taiwan SEOs are much smaller.

16. Empirical Results-Post-SEO Long-run Performance- • Taiwan SEO firms don’t exhibit long run under-performance • The result is robust to various benchmarks

17. Empirical Results-Summary Stat. by Issuer-Type- Relative to focused issuers, the diversified issuers have lower offering price and R&D intensity, but have longer listing history and larger assets amounts.

18. Univariate Comparisons However, the post-issue buy-and-hold abnormal returns for multiple-segment SEO firms show significant outperformance. The result is also robust to various benchmarks. The 3-year period buy-and-hold abnormal returns for single-segment SEO firms show significant underperformance phenomenon. The result is robust to various benchmarks including size-matched, B/M matched, and size-and-B/M matched portfolios. A test that the mean post-issue performance for single- and multiple-segment issuers are equal is rejected at 1% level.

19. Regression Results • The coefficient on HINDEX is negative and highly significant. Since increases in HINDEX represent increases in focus, it appears that equity-issue conducted by more focused firms occur more negative long-run performance. • The result supports the internal capital market hypothesis.

20. Regression Results-Endogeneity Consideration- • Campa and Kedia (2002) suggests that firms that choose to diversify are not a random sample of firms. If this case, the estimation results using OLS will be biased. • We attempt to use simultaneous equation for model 1 to control for the endogeneity, and use Heckman’s (1979) two stage procedure to control for the self-selection of firms that diversify. • The empirical results show that there still exists a significant positive relationship between diversification and post-issue performance.

21. Summary • This paper is the first to examine the effect of corporate diversification on the equity issue performance. • We find that equity issues by diversified firm results in better subsequent stock price performance than equity issues by comparable focused firms. • These findings are consistent with the hypothesis that diversification improve the efficiency of internal capital-allocation process.

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