Chapter 05

Conclusion and Policy Recommendations

5.1

Conclusion
From the above mentioned discussion it is concluded that there are two different views about

implementing diversification strategies by corporate insiders and firm value. The agency theory
based view argues that managers implements diversification strategies to get personal benefits
rather to increase the firm value. However, the alternative viewpoint argues that corporate
diversification by insiders is a useful strategic decision which improves the firm value but due to
information asymmetries, the outside investors undervalue these strategies of insiders. This is the
information perspective of corporate diversification. Both the views about corporate
diversification have different implications for corporate level policies and management literature.
In case of agency perspective, corporate diversification is considered as a value destructive
strategy. Hence, it is necessary to pay attention on improving corporate governance system to
ensure that managers focus on core competencies of their firms to increase the value. However,
in case of information perspective, corporate diversification is not considered as a value
decreasing strategy. Therefore, it is important to pay attention on enabling managers to show the
prospective advantages of corporate diversification that generate a positive signal to
shareholders.
The analysis of this study is based on insiders trading literature and provides support to the
information perspective of corporate diversification. The analysis is suggesting that insiders
considers their strategies as value increasing thats why they purchase shares of their own firm
from open market. Furthermore, they also purchase more shares of their firms when
diversification discount is high to disagree with undervaluation of outside investors. Hence, in

stock market of Pakistan the information perspective of corporate diversification is dominating

the agency perspective. So it is necessary to pay attention on enabling managers to develop more
strong mechanisms for improving information asymmetries associated with their strategies of
diversification in order to communicate the value of these strategies to outside investors rather
only focusing on governance mechanism. This could be done by improving disclosure system
and investors protection laws in stock market to work efficiently.
5.2

Policy Recommendations

Conventional wisdom among finance scholars suggests that corporate diversification destroys
shareholder wealth such that the shares of diversified firms sell with an associated
diversification discount. However, recent work contradicts earlier findings by documenting
evidence of measurement error, data sample bias and even a diversification premium. Another
important contradiction against the notion that corporate diversification destroys firm value is the
observation that many successful companies continue to embrace a diversification strategy in the
marketplace. More importantly, results from this study offer insight as to why managers continue
to pursue diversification strategies in the marketplace. These results calling for following policy
recommendations:
i.

It is recommended that regulating authorities needs to enable the managers to show

potential advantages of corporate diversification strategies that generate a positive signal

ii.

to potential investors by improving disclosure system.

Secondly, to pay attention on improving corporate governance system to ensure that

iii.

managers focus on core competencies of their firms to increase the value.

Diversification will be relatively more valuable for firms with efficient corporate
governance mechanisms, since in such firms potential agency problems such as
overinvestment and managerial entrenchment can be adequately monitored.

iv.

Diversification becomes more efficient when external capital markets are relatively
inefficient and the segments of a diversified firm would be financially constrained as
single-segment entities. Under these circumstances, external capital supply will be highly
restricted, enabling diversified firms to profit from their internal capital markets,

v.

especially during recessions and exogenous (industry) shocks.

Potential explanations include greater investment flexibility in the selection of growth
options as well as enhancement of the efficiency of internal capital markets.