The Wealth Effect and Operating Performance of Industry Rivals on Bankruptcy Filings: Diversified vs. Focused
Date Issued
2008
Date
2008
Author(s)
Chen, Yi-Ting
Abstract
Diversification has been a hot issue in the field of corporate finance. Many scholars have done empirical researches on pros and cons of diversification, and most empirical results point out the disadvantages of diversification. Nevertheless, we can still observe that many cases of diversification still exist in the business world, both horizontally and vertically. This indicates that diversification must have its value. I try to analyze and find out the advantages of diversification from the perspective of bankruptcy announcement – whether diversification provides a protection to abnormal returns and operating performances of industry rivals when one of the firms in the industry announces bankruptcy filing. If abnormal returns or operating performances of diversified rivals are significantly better than focused rivals, then we can conclude that advantages, or the protection from coinsurance effect, do exist for diversification.I use quantitative analysis and standard event study approach to see if abnormal returns and operating performances of industry rivals match my expectation. According to the empirical results of my thesis, the abnormal return of diversified rivals is not significantly different from zero around the bankruptcy filing announcement, but abnormal return of focused rivals is significantly negative. As for operating performances, similar results can be obtained. What’s more, I use cross-sectional analysis to see whether diversification does play an important role in increasing abnormal returns of diversified rivals, and the results of cross-sectional analysis supports my hypothesis. Besides degree of diversification, leverage and free cash flow are other two significant factors that bring abnormal returns downward. This indicates that agency problems exist empirically, especially when one of the firms in the industry files for bankruptcy protection.Having done researches on the wealth effect of bankruptcy filings on industry rivals, future researches may focus on the supply chain in order to discuss whether coinsurance effect also exists along the supply chain. This line of in-depth researches may bring strategic thoughts and viewpoints to decision makers of corporations as a reference of whether diversification is appropriate for the firm or not.
Subjects
diversification
bankruptcy filings
abnormal returns
coinsurance effect
Type
thesis
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