The effects of institutional ownership on the value and risk of diversified firms

•Industrial diversification is associated with lower firm value.•The value of global single-segment firms exceeds that of domestic single-segment firms.•Institutional investors and the stability of their shareholdings positively affect the likelihood that a firm is diversified.•The higher the proportions of institutional shareholdings, the higher the excess value of the diversified firm.•The higher the proportions of institutional shareholdings, the lower the firm's idiosyncratic risk.•Institutional ownership volatility is inversely related to firm value.•Institutional ownership is positively related to a firm's idiosyncratic risk.

We study the link between institutional ownership and firms' diversification strategy, value and risk. Our sample includes US-listed firms with segment data from 1998 to 2012. We find that not all kinds of diversification are value-destroying; unlike industrially-diversified firms, global single-segment firms are trading at a premium relative to their imputed value. The presence of institutional investors and the stability of their shareholdings positively influence the likelihood that a firm is diversified. The proportion (volatility) of institutional ownership is higher (lower) among diversified firms compared to domestic single-segment firms. More importantly, the higher the proportions of institutional shareholdings, the higher the excess value of the diversified firm and the lower the firm idiosyncratic risk. Institutional ownership volatility, on the other hand, is inversely related to a firm excess value but positively related to its idiosyncratic risk. Thus, the presence of long-term stable institutional investors enhances the value of diversified firms. Our findings remain robust to various model specifications and estimation techniques.