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Does vertical diversification create superior value? Evidence from the construction industry

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Abstract

The discussion of diversification discounts is one of the most controversial in corporate finance and strategic management. We are eager to reexamine this issue from the standpoint of vertical versus lateral diversification, and horizontal growth through construction industry M&A. We build on previous evidence of positive acquirer abnormal returns for vertical M&A, and we add new insight into stock return risk. Considering the high idiosyncratic risk levels of builders, we expect to find considerable informational content in systematic risk (beta) behavior, which has been neglected to date. In fact, we find that vertical M&A experience a negative asset beta shift, lateral M&A experience an increase in systematic risk, and only horizontal M&A exhibit no risk changes. Hence, our evidence on risk and previous evidence on return-induced wealth creation through vertical M&A shows that related industrial diversification is superior to unrelated—at least in the construction industry.

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Notes

  1. Matsusaka (2001), Goold and Luchs (1993), and Davis and Duhaime (1992) provide further evidence of diversification and firm performance in the management literature. The latter concentrates on vertical integration.

  2. See Moeller and Schlingemann (2005) for a discussion of lower announcement returns of global and industrial diversification.

  3. A high level of firm valuation increases managerial discretion even further, and may thus lead managers to pursue poor acquisitions when they have run out of good ones.

  4. Firm-specific investment takes into account firm stakeholders, but specifically excludes financial share- and debtholders. Firm stakeholders are those who have the greatest specific knowledge of the firm and its administrative processes, or customer and supplier loyalty. Those assets can be potentially costly for the stakeholders. Thus, stakeholder willingness to increase firm-specific investments is inversely correlated with a firm’s total risk behavior.

  5. E.g. industry classifications SIC 2,451: Real estate investment trusts; 3,272 Operators of nonresidential buildings; 5,039: construction materials; 5,199: Land subdividers and developers, except cemeteries; 6,552: Concrete products, except block and brick.

  6. E.g. industry classifications SIC 3,533: Food and Beverage; 4,119: Telecommunications Services; 4,789: Oil & Gas; 4,953: Water and Waste Management; 8,731: Commercial physical and biological research; 8,748: Security brokers, dealers, and flotation companies.

  7. Infrequent trading activity (illiquid stocks) is defined as by Corrado and Truong (2008) with 25 % or more of trading days with zero daily returns within the estimation and event period. However, the exclusion of illiquid stocks does not completely eliminate any potential biasing through liquidity issues. Diverging liquidity levels among liquid stocks remaining may still drive results.

  8. Table 9 in the appendix depicts all transactions along the time span of the study, and indicates that M&A activity (in the construction industry) follows economic cycles. Table 10 shows acquirers and targets by country.

  9. Further methodological reviews on maximum likelihood can be found in, e.g., Aït-Sahalia and Kimmel (2007), Greene (2004), and Wooldridge (1990).

  10. Based in each case on 1,000 random sub-samples of mean-adjusted CARs with sample size n/2 for which skewness adjusted t statistics are determined.

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Authors and Affiliations

  1. Chair of Corporate Finance, Department of Law, Economics and Business Administration, TU Darmstadt, Hochschulstraße 1, 64289, Darmstadt, Germany

    Malte Raudszus, Dirk Schiereck & Julian Trillig

Authors
  1. Malte Raudszus
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  2. Dirk Schiereck
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  3. Julian Trillig
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Correspondence to Julian Trillig.

Appendix

Appendix

See Tables 9, 10, 11, 12, 13, 14, 15 and 16.

Table 9 Sample overview (1/2): 119 M&A transactions between 1988 and 2007
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Table 10 Sample overview (2/2): M&As along acquirers’ and targets’ countries of origin
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Table 11 Standard event study—construction M&As along transaction volume
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Table 12 Risk event study—construction M&As along transaction volume
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Table 13 Long-term risk analysis—equity beta dynamics along transaction volume
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Table 14 Long-term risk analysis—equity/asset beta along economic cycles
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Table 15 Multivariate short-term risk analysis
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Table 16 Multivariate long-term risk analysis—GARCH equity beta changes
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Raudszus, M., Schiereck, D. & Trillig, J. Does vertical diversification create superior value? Evidence from the construction industry. Rev Manag Sci 8, 293–325 (2014). https://doi.org/10.1007/s11846-013-0105-5

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