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 firms, indicates that the value of diversification increases when external capital is costly or difficult to access. This pattern is salient for firms with relatively low cash holdings, tight financial constraints, and integrated organizational structures, suggesting that it is rooted in the internal capital markets of diversified firms. Moreover, consistent with the role of coinsurance, which protects firms from financing shocks by enabling their divisions to cross-subsidize, the value of diversification responds more sensitively to capital market conditions for firms operating in industries with heterogeneous cash flow fluctuation patterns and for firms with higher bankruptcy risk. We also document that segmental investment is positively affected by the cash flow of other segments in the firm, especially when external capital markets are under stress. These results suggest that the value of corporate diversification fluctuates because macroeconomic shocks change the relative value of internal and external capital markets.