Corporate Diversification Discounts: Incentives Diminishing and Investment Misallocation

By building a model of internal capital markets, we draw conclusion that allocation resources in divisions of diversified firms depends not only on output efficiency of division but also on stimulation level of division managers. Therefore diversified firms suboptimally invest by subsidizing poor performing business segments with resources from profitable business segments, which bring resources misallocation and harm corporate value. We take a closer and more critical look at diversification discount by this theoretical research.