International Research Journal of Finance and Economics

ISSN 1450-2887 Issue 35 (2010)

© EuroJournals Publishing, Inc. 2010
http://www.eurojournals.com/finance.htm

The Impact of Diversification on Firm Performance and

Risk: An Empirical Evidence

Ines Kahloul
Corresponding Author, Department of Finance
Higher Institute of Management
41, rue de la liberté, Bouchoucha-2000 Bardo
E-mail: ines_kahloul@yahoo.fr

Slaheddine Hallara
Department of Finance, Higher Institute of Management
41, rue de la liberté, Bouchoucha-2000 Bardo

Abstract

The aim of this paper is to analyse and to test the influence of the activity perimeter
on the firm performance and risk. The empirical tests follow two stages, a first one
consisting in studying the diversity evolution of a sample of largest French groups. The
second consists in studying the nature of the relationship linking the diversification level to
the firm’s risk and performance. A longitudinal study enabled us to confirm the movement
of corporate refocusing from both Herfindahl and Entropy indices. A multivariate analysis
is included with dynamic panel data and finally a non monotonous relationship
diversification-performance, diversification-risk are checked.

Keywords: Diversification, refocusing, performance, risk

1. Introduction
The announcements and the practices of firms are worked today, by two roads in dialectic tension: the
financial road which focuses on the concentration as a strategy of risk mastery and the durable road
that privileges the diversification to distribute the risk (Martinet, 2006). The diversification strategy
constitutes a field of investigation for management risk researches. The financial road focusing on
short term horizons incites to a concentration of the risk and a standardization of the growth models.
Whereas the durable road rather oriented on long term horizons, privileges the diversification strategy
by a distribution of the risk. The aim is to maintain and to develop the value creation potential with
regard to the different parts. Thus, several studies were interested to the impact of the strategy
developed by the firm on the performance.
The theme of the diversification-performance relation, probably one of the most studied in the
literature, is yet far from being exhausted (Palish and al, 2000). Since the 70th the academic research
tried to check the relation between diversification strategy and firm performance. Nowadays, the
problematic of the firm activity perimeter evolution is an interesting subject so much in industrial
economy, in strategy or in finance.
The majority of theoretical and empirical works are characterized by a plurality in the sense that
they can be opposite and have changed more and more rapidly. Besides, the strategic study exam
International Research Journal of Finance and Economics - Issue 35 (2010) 151

achieved on the theme of diversification reveals that most of these studies ignored the risk aspect, as
well as the managerial objectives pursued. The motivation of reduction of risk by diversification
(Amihud and Lev, 1981; Wright and al, 2007), highlighted in the literature, contributes largely to
explain our choice to integrate the notion of risk in our present study. This is a post motivation letting
us to investigate the mechanism of diversification of the firm in the French context to better seize its
particularities.
The present work is interested to the double impact of the diversification on performance and
risk. In Lang and Stulz (1994) and Berger and Ofek (1999), an objective continuous measure of the
strategic diversity of the firm based on the Herfindahl index has been used. In the present work, we
compute the Entropy index in order to confront the results inherent to the two indices and to test the
consistency of the analysis.
Otherwise, most studies are concentrated on cross-section analyses. Differently, our work uses
a longitudinal data from a sample composed of 69 large French firms quoted on the period of 1995-
2005, in order to analyze the firm activity perimeter evolution effect on its level of risk and
performance in a dynamic prospect. The empirical survey conducted on the French context is going to
provide answers associated to double objectives: retracing the evolution of the diversity of the large
French groups and testing the main current theoretical validity on the relation between diversification
and performance, with the integration of risk.
The present work is organised as follows: In Section 2, the hypothesis and the variables are
presented. In section 3, a description of French firms’ selection is provided, the research methodology
is developed and data analysis is conducted. Furthermore, a synthesis of founded results concerning the
operations of refocusing and strategic diversification in France and their impact on the performance
and on the risk of the firm is provided. We conclude afterwards.
We just recall before going one developing the paper that the present work is inspired from our
work Kahloul (2008) which was presented as a conference paper in the 5th colloquium of the ADERSE
held in Grenoble, France, January 10-11, 2008. However, there are some minor modifications carried
on the conference paper. The sample size is reduced from 76 firms for the conference paper to 69 in the
present study. This is just for estetique of the paper while a complete study is already provided in our
paper Kahloul (2008). Next, some variables are added. These are the Return on Assets (ROA), which is
retained to assess the level of performance of the firm. It indicates that the company has generated as
earnings at the end of its investments. Next, the Growth of the firm (GROWTH) which is one of the
explanatory factors the most important of the performance of firms. These variables are mentioned but
not included in the empirical study in the conference paper. We added them for a complete empirical
study here.

2. Hypothesis and Variables

A large and a well developed literature were interested to the survey of the gains and costs of the
diversification strategy (Comment and Jarrel (1995), Denis and al (1997), Rajan and al (1998), Rajan
and Zingales (2000), Bhagat and al (1999), Campa and al (2002)). Despite a general agreement that
seems to be observed concerning the negative impact of the diversification strategy on the performance
of the firm (Lang and Stulz (1994), Berger and Ofek (1995), Serveas (1996), Lins and Serveas (1999)),
mitigated results are observed in other studies (Bodnar and al (1997), Stein (1997), Miller (2006)). A
large number of academic works relatively to the French context has tested this relation. The reduced
number of French studies (Perdreau (1998), Godard (1996), Maurer (2003)) does not allow us to
decide on the nature of this relationship and therefore justifies new tests.
Based on the developments of the literature, several hypotheses are developed. The first
hypothesis is about the relationship diversification-performance. It is stated as
H 1: The strategy of diversification presents a negative impact on the performance of the firm.
152 International Research Journal of Finance and Economics - Issue 35 (2010)

However, a possibility of questioning of the linear nature of this relationship is observed (Grant
and al (1988), Hoskisson and Hitt (1990), Denis and al (1997)). A second hypothesis dealing already
with the same relationship is the following.
H2: A U-shaped curvilinear relationship exists between diversification and performance.
Next, a main object is to contribute to the understanding of the diversification-performance
relation while integrating a primordial dimension in the analysis about the risk and its components. The
following risk relationship can be hypothesized.
H3: The diversification is associated to a reduction of the firm risk.
Based on the reconsideration of the implicit hypotheses of Amihud and Lev (1981) on the
managerial behaviour, especially on the risk aversion, and on the behavioural perspective developed by
Wiseman and Gomez-Mejia (1998), hypothesis H3 is refined next to the following.
H3': Performant firms satisfy the presence of a negative relation between diversification and
risk. This relation is not observable, or less strong, for the low performant firms.
The tests include variables of performance, diversification and risk and some control variables.
The performance: Two performance measures are identified based on accounting and stock
market data: Tobin’s Q and Return on Assets.
• Tobin’s Q (Q): The Tobin’s Q is computed as the ratio of Stock capitalization added to
financial debts on Total assets. That is

Stock Capitalization + Financial Debts

Q=
Total Assets

• Return on Assets (ROA): The ROA is the ratio of the operating result (current income before
tax) and the assets of the company. i.e
O perating R e sult
RO A =
Total Assets
The Diversification Strategy (H,E): The measure of the diversification of the firm has been
valued from two continuous measures: the Herfindahl index and the Entropy index. The Herfindhal
index is computed as
n
H = ∑i=1
Pi 2
where n is the number of the firm’s activities and Pi is the relative weight of each activity evaluated as
the proportion of the sale xi of the activity i of a firm.
The Entropy index is defined by
n
E = − ∑i=1
Pi ⋅ l n Pi
The Entropy index varies therefore oppositely to the Herfindhal one.
The risk (ETYP): The total risk of the firm is estimated from the market data. It is appreciated
by the standard deviation of stock returns. The specific component corresponds to the standard
deviation of residues of the right of the market of each title. The market risk or the systematic risk is
measured through the variance of the market multiplied by the beta of the firm.
The size of the firm (SIZE): It is essential to control the size of the firm sample that is
supposed to act on the performance. We kept as variable of control the size of every firm measured by
the logarithm of the total asset of the group.
The debt (DEBT): The variable of the debt is measured as the ratio of the total debts and the
shareholders equity.
International Research Journal of Finance and Economics - Issue 35 (2010) 153

The Growth of the firm (GROWTH): The growth of the company is one of the explanatory
factors the most important of the performance of firms. This variable is measured by the average
variation of the turnover on the reporting period. That is
Sales n - Sales n -1
G RO W TH =
Sales n -1

3. Empirical Results and Discussions

As it is mentioned in the introduction, the sample is composed of 69 non-financial French firms quoted
on the period 1995-2005. The data are extracted from the “Thomson Financial” basis. The choice of
the sample is motivated by the following criteria: (1) important size; the sales exceeded in general 100
M€ on the set of the 11 years (Palard, 2006). (2) Total period 1995-2005, (3) Industrial activity;
elimination of the firms whose main activity corresponds to the sectors Banking-Finance-Insurance. (4)
A quotation historic being sufficient on the whole period of the survey. The diversity of companies’
activities was also considered at the level of the groups which eliminates the subsidiaries listed of these
groups. The choice is also related to the study of the diversification behaviour due to the biggest
French industrial groups quoted and by some constraints related to data availability.
The methodology for analyzing data is based on univariate and multivariate analysis. In the
first, the Herfindahl and the Entropy indices are based on the distribution of the sales by activity which
allows the definition of the diversification strategy level for each firm. The multivariate analysis allows
highlighting the firm activity perimeter evolution effect on the performance and on the risk of the firm.
The data being in both time series and cross sectional, we have thus made regressions using a panel
data. Moreover, in a methodological point of view, one of the assets of this paper is to study the
evolution of activities’ perimeters of French firms listed from the panel data. The double cross-
sectional and temporal dimension data increases the number of comments and improves the quality of
estimators.
Table 1 hereafter resumes the descriptive statistics of the variables on the whole period (1995-
2005): mean, maximum, minimum and standard deviation. The diversification variable is measured by
two indices: the Herfindhal index (HERF) and the Entropy index (ENTROP) which measure the
concentration of the sales by activities. The performance is evaluated by the Tobin’s Q (Q) and the
Return on Assets (ROA). The risk is measured by the standard deviation of the return equity (ETYP).
The log of total assets measures the size of the firm (SIZE). The (DEBT) variable corresponding to the
total debt/Total equity, presents the debt of the firm. The growth (EVOLCA) is measured by the
variation of the turnover of the company. The number of observation is 759.

Table 1: Descriptive Statistics

ENTROP HERF Q ROA ETYP SIZE EVOLCA DEBT

Mean 0.964 0.495 1.0102 0.033 0.085 3.529 0.112 1.153
Maximum 2.258 1.043 5.646 0.453 0.408 5.178 20.450 28.203
Minimum 0.000 0.109 0.042 -0.663 0.017 1.892 -0.614 0.008
Standard deviation 0.509 0.242 0.723 0.058 0.043 0.735 0.763 1.719
Observations 759 759 759 759 759 759 759 759

Table 2 below provides the correlation matrix of all endogenous and exogenous tested
variables.
154 International Research Journal of Finance and Economics - Issue 35 (2010)
Table 2: Matrix of correlations

ENTROP HERF Q ROA ENDT SIZE EVOLCA ETYP

ENTROP 1.000
HERF -0.960 1.000
Q 0.012 0.019 1.000
ROA -0.137 0.172 0.391 1.000
ENDT -0.022 0.045 -0.175 -0.159 1.000
SIZE 0.175 -0.145 -0.039 -0.095 0.170 1.000
EVOLCA -0.033 0.047 0.011 0.023 0.045 0.033 1.000
ETYP 0.107 -0.111 -0.036 -0.273 0.141 -0.008 -0.033 1.000

We observe that the level of diversity of firms in the sample varies between two extremes
thresholds: a significant level of diversification and a low level akin to a strategy of specialisation, as
show the minimum and maximum values of the Entropy and Herfindhal indices. Beyond these
extremes, the middle Entropy index shows a level of diversification fairly high for the studies firms.
This finding is compatible with the large size of firms in our sample. The return on assets presents an
average less than 1. While, the average value of Tobin’s Q is greater than 1. We agree for this last
value the majority of the work having recourse to this measure and which present an average of the Q
means and median near 1. The measures stock market performances seem to indicate in average a
future creation value for the firms considered. The average debt of firms is high. Furthermore, the
amplitude of variation is as strong as evidenced by the standard deviation. The similar observation is
advanced for the growth variable.

3.1. Study of the Diversity of the French Companies (1995-2005)

The evolution of the diversification strategy of 69 French industrial groups has been evaluated by using
two measures: the Herfindahl index and the Entropy index based on the distribution of sales. The
Entropy and Herfindhal indices are evaluated for each year of the period of 1995-2005. The idea
behind this synthesis is to confront the result of the two-dimensional of the two indices and thus to
ensure the coherence of the analysis.
In order to more understand the evolution of the diversity level of the French groups sample,
we started by computing the average Entropy and Herfindhal indices. Table 3 incorporates these data.

Table 3: Evolution of the mean of Entropy and Herfindhal indices

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
H 0,49752 0,49750 0,49742 0,49734 0,49728 0,49729 0,497322 0,497329 0,49733 0,49735 0,49736
E 0,95783 0,95784 0,95813 0,95846 0,95869 0,95833 0,95791 0,95755 0,95721 0,95702 0,95691

The evolution of the mean Herfindhal index shows that the index is slightly decreasing until
1999 and it starts to increase from 2000. Correspondingly, the Entropy index has experienced a change
in direction. Therefore, we may deduce from these results, that the evolution of the portfolio of
activities of the major French groups quoted can be characterized by two phases.
The analysis of the evolution of means’ indices shows that the evolution of the diversity is
characterized by a low magnitude during the first period, but from 2000, the tendency to refocusing
seems to emerge clearly. This is also shown in Figure 1 and Figure 2 hereafter. More precisely, Figure
1 shows that Entropy index has experienced a downward trend from 1999. This stipulates a decline in
the level of diversification of groups of the sample. Figure 2 shows an increase of the Herfindhal index
from 1999. This stipulates a tendency to refocusing of the groups and therefore a decline in the level of
diversification.
International Research Journal of Finance and Economics - Issue 35 (2010) 155
Figure 1: Evolution of the Entropy index

Evolution of the entropy index based on sales

0,959

0,9585
Mean entropy index

0,958

0,9575 entropy index/sales

0,957

0,9565

0,956
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Year

Figure 2: Evolution of the Herfindhal index

Evolution of Herfindhal index based on sales

0,49755
0,4975
Mean Herfindhal index

0,49745
0,4974
0,49735
Herfindhal index/Sales
0,4973
0,49725
0,4972
0,49715
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Year

These results indicate that the portfolio activity evolution of major groups quoted in France can
be marked by two successive phases. A first one characterized by a degree of stability in the evolution
of the Herfindhal index downward and a slight increase in the Entropy index to the increase, which
shows a stability in the diversification strategy. A second phase corresponding to an increase of the
Herfindhal index and to a decrease of the Entropy one shows the trend of groups to reduce their level
of diversity which is equivalent to a movement of strategic refocusing.
For more precision, and to be able to pursuit the observed trend, we have held to analyze the
evolution of the diversity during the periods, 1995-1999, 2000-2005 and 1995-2005. The choice of
such decomposition is based in one hand, on the results due to the analysis of the evolution of the
calculated mean indices. On the other hand on our motivation to compare our result to the results of
previous works especially those held on the 90th and to observe the diversity level evolution of French
groups up to a recent period.
We considered the number of firms for which the Herfindhal index evaluated in the rising, in
the decline or remained stable between extreme years of each sub-period and the overall period 1995-
156 International Research Journal of Finance and Economics - Issue 35 (2010)

2005. Similar computations have been carried out as with the Entropy index. The results are provided
in Table 4 and Table 5 below.

Table 4: Diversity evolution of French groups (1995-2005) with Herfindhal index

1995-1999 2000-2005 1995-2005

H increasing 35 43 47
H decreasing 27 16 16
H stable* 7 10 6
Total 69 69 69

Table 5: Diversity evolution of French groups (1995-2005) with Entropy index

1995-1999 2000-2005 1995-2005

E rising 30 19 25
E in decline 36 48 42
E stable* 3 2 2
Total 69 69 69

The star (*) means that when the rate of variation is less than 1%, the evolution of the index is
considered stable
Let us examine more the results shown in the tables 4 and 5. The main points to be well noticed
are resumed to the following
• Table 4 shows that Herfindahl index has a slight tendency to increase more than to
decrease along the period 1995-1999. Besides, the Entropy index seems to decline
slightly more than being upwards. During this period a slight trend to the refocusing
seems to emerge but not clearly predominant. The number of groups with sales in
dispersion is close to that of groups with sales in concentration.
• The period of 2000-2005 provides a clearer idea on the observed trend. The slight
increased tendency observed during the previous period is strengthened during the
present one. The diversification of groups has decreased in the period 2000-2005
compared to the previous one. The number of Herfindhal index in decline is reduced
from 27 during 1995-1999 to 16 for 2000-2005. Correspondingly, the Entropy index has
an opposed development as shown in Table 5. During the period 2000-2005, the number
of decreased Entropy index being equal to 48 is higher than that increased which equals
to 19. The trend to the refocusing, which is reflected by the concentration on a reduced
number of activities, emerges allowing a slow diversification movement during 2000-
2005, to leave a movement of tightening of activities.
• The same observation is observed for the entire period 1995-2005, which is checked
through the evolution of the Herfindhal index (68% rising against 23% in decline) and of
the Entropy index (61% in decline against 36% rising). It seems that firms tend to
concentrate on a single activity. They may also submit a non-egalitarian distribution of
sales between several activities, only an activity in this case would present a significant
part of sales. In both cases, the general trend observed is a tightening of activities, which
has worsened during the time. It emerges from this analysis, that the tendency to promote
a sector constitutes the most important characteristic.
Because of these findings, we can conclude to the predominance of the movement of refocusing
during the period 2000-2005 for the majority of French groups. However, although this number is
reduced compared to the previous period, a number of groups continue to diversify.
Our concluding suggestions can find their explanation in the contribution of the internal and
external markets theory, which considers the financial function of groups as the places of allocation of
capital alternative to the financial "external" markets. The decline in the level of diversity may be due
International Research Journal of Finance and Economics - Issue 35 (2010) 157

to the financial role of shareholders in the conglomerates firms (internal market) which has lost its
interest with the active development of financial markets. Declining level of diversity can be explained
also by a constraint of performance and the need to seek a strong position on the competitive markets.

3.2. Diversification and company value

In this section we conduct multivariate analyses of the diversification effect on the performance
variables. We have provided after the conceptual development a possible curvilinear relationship
between diversification and performance. The highlighting of this relationship should take into account
other variables such as size, debt, growth and risk. To test the possible presence of a correlation or a
defect of specification, we have applied the well-known Hausman test. The regressions are carried out
according to the technique of least squares taking into account a possible heteroscedasticity of residues.
Many regressions have been carried out integrating different performance and diversification measures.
The data collected on 69 French groups quoted has allowed us to estimate the following
econometrical model of panel data in considering the existence of individual fixed effects between
firms:
P E R F ( Q , R O A ) it = α 0 + α 1 D I V E R it + α 2 S I Z E it + α 3 D E B T it
+ α 4 E V O L C A it + α 5 E T Y P + ε it .
Table 6 shows the regressions using as an explained variable the Tobin’s Q and the ROA. The
results of our empirical examination provide finer insights into the debate concerning the impact of
diversification on performance.

Table 6: Effects of diversification on performance (Q,ROA)

Dependent Variables
(1) (2)
Independent variables
Q ROA
1.686*** 0.105***
Constant
(5.13) (2.81)
-0.899*** -0.072*
Entrop
(-2.71) (-1.92)
0.801** 0.082**
E2
(2.18) (1.99)
-0.222** -0.025**
E3
(-1.90) (-1.92)
-0.301*** -0.011
Size
(-3.10) (-1.14)
0.007 0.001
Debt
(0.56) (0.79)
0.022 -0.002
Evolca
(1.06) (-0.71)
-0.237***
Etyp
(-4.80)
F 1.81* 3.92***
Adj. R2 0.02 0.03
N 759 759

The numbers in the parenthesis are robust t-statistics. The stars *, **, and *** indicate
statistical significance at the 10%, 5% and 1% levels respectively.
Regressions of the performance measures (Q,ROA) on the diversification E, E2 and E3
correspond respectively to the square and the cube of the variable E. The control variables are: the size
(SIZE) measured by the logarithm of the total assets, the debt evaluated by the relationship between
total debts and total equity, the growth (Evolca) measured by the company turnover variation and
158 International Research Journal of Finance and Economics - Issue 35 (2010)

finally the risk (Etyp) measured by the standard company share returns deviation. The number of
observations is fixed to N=759 for each regression.
The results of the linear regressions display no significant result. The impact of the
diversification on the performance is certainly negative but not significant. It is even with the
Herfindhal index. These results not satisfying the assumption H1 as we have suggested, encourages us
to test the non linearity of this relationship. By introducing the square and the cube of the Entropy
variable E in the regressions, a relationship in three stages is observed. We noticed that the
performance decreases in a first step (the coefficient of the Entropy E is negative and significant), it
then increases with the level of diversification with an entropic measure of 1.19 with Q and 1.07 with
ROA. The coefficient of E2 is positive and significant. The performance decreases again beyond a
certain threshold with an entropic measure of 1.26 with Q and 1.11 with ROA. The coefficient of E3 is
negative and significant. We recall finally that we have introduced the risk as a control variable only in
the regressions containing the accountant’s measures of performance ROA. In fact, the Tobin’s Q is
implicitly adjusted to the risk. Due to Charreaux (1997), it is evaluated from the values market which
takes account of risk premiums requested by the investors.
The first negative phase observed can be explained by expenditures incurred for diversifying
the firm, which may affect its growth opportunities. Besides, the financing of the diversification can
induce a reduction in the expenditure in research and development and following a decrease of
innovation, which may affect the performance of the company. For the second phase, the positive
effect of the diversification on the performance prevails over the negative effect already observed. The
diversification situated in an intermediate level begins to generate value for the company. An
intermediate level of diversification appears to increase profits and gains in terms of performance. This
phase can respond to that where the benefits of diversification are still lower than the linked costs.
According to Markides (1992), these benefits can be related to the various synergies that it can present
and to the gains of exploitation of existing resources.
We note, however, that the negative effect of the diversification level on the performance is
observed of new beyond a certain threshold of diversification. Such a negative impact can be justified
by the costs of diversification, which go beyond a fairly high level of diversification, its benefits. The
deterioration in the level of performance is observed when the additional costs exceed the profits in
terms of efficiency (Jones and Hill (1988) and Markides (1992)). The existence of limit to the
diversification is explained in terms of marginal profits and costs associated with such a strategy. The
conclusion, which we end up is that beyond the point of intersection between the two curves of costs
and benefits, the diversification entails a reduction of performance. Each firm has a point of
equilibrium which is specific and which corresponds to the intersection between marginal costs and
marginal benefits. This point can be function of the resources available to the company, to its
environment, its type of diversification, the capacities and skills of its management team, etc. The size
presents a negative effect on the performance measures. This can be interpreted by the fact that
throughout their growth, the companies exhaust their profitable investment opportunities. The debt of
the firm presents also a negative but a non-significant impact. We can emphasize that the companies
very indebted would have exhausted in part, their opportunities of investments.

3.3. Diversification and the Company's Risk

The regressions carried out joint the measures of the risk to the diversification firm variables. The next
model has been estimated considering the existence of random effects between firms:
R I S K it = α 0 + α 1 D I V E R it + α 2 S I Z E it + α 3 D E B T it + ε it .
Table 7 resumed the regressions explaining the level of risk of the company by its level of
diversity.
The test of linear model between the total risk and the diversification do not supply significant
result. The same thing is observed for the specific risk and the diversification. However, a positive and
significant linear relationship is satisfied for the diversification, when the systematic risk is introduced
International Research Journal of Finance and Economics - Issue 35 (2010) 159

as explained variable (regressions 2 and 3). A reduced level of diversification reduced the systematic
risk, while an increase in the level of diversification increased it. The same result is obtained by
introducing the Herfindhal index as dependent variable. The interest of this estimate is to understand
the effect of the diversification strategy on the market value of the firms. Our result joined the famous
result of Montgomery and Singh (1984). We thus conclude that the diversified firms increase the
market risk and these firms tend to have an important financial leverage.
The first regression takes the standard deviation of shares returns, which corresponds to total
risk of the firm, in explanatory variable. A non-linear relationship is checked. At a low level of
diversification, the total risk decreases, increases then for a level of diversification located between
1.02 and 1.06 (entropic measure), decreases after, beyond 1.06 The assumption H3, which suggests a
negative relationship between diversification and risk, is corroborated at different levels of
diversification.

Table 7: Effects of diversification on firm risk

Dependent variables Global sample: 69 groups

(1) (2) (3) (4)
Independent variables
Totrisk Systrisk Systrisk Spefrisk
Constant 0.009** 0.001*** 0.0014*** 0.009**
(2.29) (2.83) (4.30) (2.14)
H -0.0006***
(-2.69)
E -0.013* 0.0003*** -0.013*
(-1.71) (2.49) (-1.74)
E2 0.019** 0.019**
(2.26) (2.26)
E3 -0.005** -0.006**
(-2.29) (-2.29)
Size -0.0005 -0.0001* -0.0001* -0.0004
(-0.52) (-1.68) (-1.65) (-0.35)
Debt 0.001*** 0.0001*** 0.0001*** 0.001***
(3.83) (2.88) (2.94) (3.65)
Wald 26.04*** 14.84*** 15.89*** 24 .03***
Adj. R2 0.08 0.06 0.07 0.08
N 759 759 759 759

The regression 4 considers the specific risk as an explained variable. The relation is significant
when it is non-linear. The relationship varies according three levels. The mean variation of the specific
risk follows that of the total risk of regression 1. It decreases in a first step, increases then to a
threshold 1.22 for diversification, and decreases beyond 1.27. Our findings join partially those of
Lubatkin and Chatterjee (1994) yielding a minimal risk for a reduced diversification strategy. In the
cited reference, an empirical analysis shows that the limited diversification strategies allow a decline in
the risk, while the large diversification strategies lead to an increase since they do not allow qualifying
for synergy. We thus conclude that the manager can find a possible satisfaction in the reduction of the
specific and total risks (Amihud and Lev (1981)). We can note however, that our results show that the
hypothesis of reduction of risk due to Amihud and Lev (1981) can not be applied for all levels of
diversification.
Next, we have conducted the amendment of the assumption H3 and we borrowed the logic of
Wiseman and Gomez (1998) as a part of a behavioral perspective and which suggests that the behavior
of the risk reduction by diversification could be observed for the most efficient firms. Thus, we have
resumed the same regressions retaining firms with a Tobin’s Q exceeding the median of the sample.
We thus obtained a reduced sample consisting of 34 groups. The main results are shown in the Table 8.
160 International Research Journal of Finance and Economics - Issue 35 (2010)
Table 8: Effects of diversification on firm risk

Dependent variables Reduced sample 34 groups

Independent (1) (2) (3)
variables Totrisk Systrisk Spefrisk
Constant 0.0004 0.001*** 0.0007
(0.06) (2.36) (0.11)
E 0.004** 0.0002* 0.004**
(2.21) (1.60) (2.10)
Size 0.0002 0.0002 0.0005
(0.08) (2.04) (0.26)
Debt 0.004*** 0.0002*** 0.003***
(6.11) (4.87) (5.70)
Wald 46.31*** 31.5*** 40.78***
Adj. R2 0.12 0.13 0.12
N 374 374 374

It shows regressions of the risk and its components Totrisk, systrisk and Spefrisk on the
diversification E. The number of observations is N=374 for each regression. We noticed that there is a
positive relationship between diversification and risk and its components. An increase of the diversity
can therefore increase the risk of the firm. The assumption of risk reduction does not occur on our
reduced sample. This may explain further the decline of the diversification for the majority of groups.
Besides, we can explain our present result by the fact that the Tobin’s Q is considered as a measure of
the risk aversion, and then it appears normal that on our reduced sample having a Tobin’s Q higher
than the median, that we are seeing risk-taking.
We expect a positive impact of the leverage on the risk of the firm. This relationship is
observed for all regressions: a higher leverage increases the average rate of return on equity, but also
their volatility. The effect of the size is positive but not significant.

4. Conclusion
In this paper, we sought to measure and to explain the evolution of the strategic business perimeter of
the French firms on a sample of 69 large industrial quoted groups. The results highlight that the
strategic trend followed by the French firms is equivalent, primarily between 2000 and 2005 to a
refocusing strategy. The decline of diversity observed on our sample suggests that the managers limit
their strategy to reduce their employment risk, away the firm of risks related to a large diversification.
In a second stage, building on theoretical developments and empirical results in strategy and finance,
we sought to study the relationship diversification/performance and diversification/risk. We noticed a
non-linear relationship diversification/performance. A relationship diversification/performance in three
stages (ROA and Q) is checked. It shows that an intermediate zone between a specialization and wide-
ranging diversification corresponds to the area of performance and value creation. The existence of an
optimum of diversification that may vary between firms, can explain the development of the refocusing
for some of them and the continuation of the diversification for some others. This result seems to plead
in favor of an intermediary strategy between the diversification and specialization, which could
respond to the objective of durable development for the company.
To complete the study on the link diversification/performance, we conducted regressions on the
impact of diversification on the risk and its components. The results show a non-linear relationship
between total risk, its specific component and the diversification. A positive linear and significant
relationship is rather checked between diversification and systematic risk. We join the result of
Amihud and Lev (1981): If the managers find a possible satisfaction in the reduction of the specific
and total risks, the shareholders may suffer from a too large diversification with constant profitability.
This result can be compatible with any opportunistic manager behaviour. Besides, our result shows that
International Research Journal of Finance and Economics - Issue 35 (2010) 161

the reduction risk by diversification hypothesis is not checked for all levels of diversification. Based on
behavioural perspective we have resumed the same regressions on a small sample presenting the most
efficient firms. The risk and its components increased with the level of diversification. This can justify
the decline of the level of diversification on our sample.
The consequences observed in the diversification on the risk and on the performance contribute
to explain therefore, the evolution of this strategy during the time. Among other, the mechanisms of
control and the weight of shareholders within the firm, could justify the trend to the refocusing of the
majority of firms, observed on our total sample. In extending these findings relating to diversification,
performance and risk, it could be quite important to explore the role of mechanism of Governance in
the determination of the diversification strategy. In particular, the ownership structure could potentially
moderate the relations between diversification-performance and diversification-risk. It is quite possible
that the nature of ownership could be salient to understanding the diversification, performance and risk
relationships.

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