Corporate diversification and firm value during economic downturns

• We document a significant improvement in the relative valuation of diversified firms during recessions.
• The relative value converges back to its pre-recessionary levels in the four quarters following the trough of recession.
• There is no evidence that the improvement in relative value is driven by diversified firms’ superior access to external financing.
• The evidence suggests that, at least in part, the increase in relative valuation of diversified firms is a result of an improvement in the efficiency of internal capital allocation during recessions.

This paper examines the effect of corporate diversification on firm value during periods of economic downturns. Analysis of diversified firms’ valuation during recessionary periods reveals a significant increase in relative value of diversified firms. The observed improvement in the relative valuation is only a temporary phenomenon, which disappears in the four quarters following the trough of the recession. We do not find support to the hypothesis that the improvement in relative valuation of diversified firms during economic downturns is attributed to the ability of diversified firms to utilize broader external capital markets. We demonstrate that the improvement in relative valuation is largely driven by diversified firms that are financially constrained, and, therefore, attribute the observed improvement to more efficient internal capital allocation during recessions.