CORPORATE DIVERSIFICATION: A CATERING THEORY APPROACH

Abstract

This thesis examines the conglomeration and refocus wave of the 1960’s through 1980’s and corporate diversification, more generally, from a behavioral corporate finance perspective. Applying catering theory to diversification via mergers and acquisitions, this thesis hypothesizes that investors are less than fully rational in their valuation of diversified companies and that rational managers perceive subsequent mispricing and cater to temporary investor demand for corporate diversification by acquiring unrelated businesses to maximize current shareholder wealth. Empirical tests of this hypothesis provide supporting evidence. First, the propensity of managers to initiate diversifying acquisitions is increasing in measures of market preferences for diversified companies. Second, investors systematically misprice diversified companies as indicated by low future excess returns of diversified companies. Third, managers are more likely to cater to investor demands during periods when investor overvaluation of corporate diversification is most severe.