Value Creation Diversification Strategies Research

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North-Holland) 337-429.

This scholarly article looks to establish a correlation between payout policy and valuation within publicly traded international companies. Here, the authors look to evaluate if a diverse payout policy will lead to stable valuations and risk. Risk in this article is defined using the term “Beta” which is the covariance between the publicly traded stock price and the market as defined as the S&P 500. The initial hypothesis from the authors is that investors have varying preferences as it relates to risk and return characteristics. These characteristics can include high yield in the form of dividend or higher growth.

In the case of higher yield, investors will look to emphasize dividend growth as a barometer for value creation. Other investors however, would rather the company retain all of its earnings in the business so that it may compound money internally at a much faster rate than could otherwise be achieved through dividend growth. To appease both sets of investors, companies diversify their payout strategy as a means of attracting a larger investor base.

From the scholarly report, it was found that companies that use a diversified approach towards their payout ratios, typically have a much smaller beta than companies that don’t payout any dividends. According to the authors, dividend is viewed by the market as a much more stable value creation tool of investors. As such, companies are often heavily reluctant to reduced their dividend payouts to investors. As such, as it relates to value creation, growth in dividends overtime has shown to increase stock prices while a reluctance to decrease reduces overall volatility of stocks relative to non-dividend paying stocks

That data looks at a subset of roughly 1000 publicly traded companies using data from Moody’s, Standards and Poor’s and other rating agencies. The appropriateness, and the methodology used to evaluate each stock is sound, with heavy reliance on the Modigliani and Miller dividend irrelevance proposition. The limitations of the research are heavily related to the time frame evaluated which was the 20-year period from 1990 to 2010. This period may not be indicative of what has occurred throughout history. The author Franklin Allen is business professor at University of Pennsylvania and Roni Michaely is finance professor at Cornell University.

Amihud, Yakov, and Baruch Lev, (1981), Risk reduction as a managerial motive for conglomerate mergers, Bell Journal of Economics 12: 605–617

This scholarly article looks at value creation in terms of risk reduction for investors and other key stakeholders. Here, value is often “created” by reducing large volatility in business operations. Through having a diversified earnings stream, declines in one operation could potentially be overcome by increases in another business segment. Value is thus created as earnings are now much more dependable and stable. With larger and dependable earnings, investors are much more willing to pay premium prices to own the security and pay demand lower interest rates on debt issuances. The primarily reason for this is that, investors can more accurately forecast the future earnings of the business and can therefore more reliably predict valuations of the business into the future. For this certainty, investors are willing to pay higher prices, thus creating stock price appreciation through diversification of product offerings. This value creation also expends to employees, communities and other stakeholders who can depend on the organization to be a stable pillar. Here diversification of operations creates stable tax revenue, stable job prospect, and other elements that can lead to value creation for stakeholders other than shareholders.

The article reviews the incentives of mergers within a conglomerate structure to reduce risk and ultimately maintain stable operations. The authors use the agency-cost model to evaluate management risk reduction capacity. This hypothesis about conglomerate merger motivation is empirically examined in two different tests and found to be consistent with the data. The topics are appropriate for its intended audience with the limiting factor being the overall sample size evaluated. This is limiting as the number of conglomerates engaging in merger and acquisition activity often varies year to year. Likewise, motivational factors are often determined by macro-economic factors prevailing at the time adding further complexity to the analysis. The authors Yakov Amihud and Barush Lev are both executives of the RAND corporation, a nonprofit institution that helps improve policy and decision making through research and analysis. RAND focuses on the issues that matter most such as health, education, national security, international affairs, law and business, the environment, and more.

Amit, R. and J. Livnat (1988). Diversification and the risk-return trade-off, Academy of Management Journal, 31: 154–166.

This scholarly article reviews the risk return tradeoff of diversification from a value creation perspective. Here, the scholarly article, reviews data from investment portfolios of both institutional, pension funds, insurance, corporate and retail investors. Emphasis of this article was placed on corporate strategy as it relates to their investments in both publicly and non-public companies. The authors found that diversification of investment heavily reduced risk without a corresponding declined in return. Here, the authors leverage the capital assets pricing model used to help evaluate corporate strategy investment. The model uses the capital markets line and the efficient frontier to determine the most optimal return for the lowest amount of risk. This portfolio, according to the authors typically consists of a combination of risk-free treasury securities and common stocks.

From the corporate strategy perspective, the authors not the importance of cash and treasury security balances as a means of helping to reduce business risk. Having a large amount of cash helps to create value as corporations can also be opportunistic as it relates to their ability to acquire companies during a economic downturn. This ultimately creates value for shareholders as they are able to obtain stakes in promising companies at a fraction of their intrinsic value. The authors Raphael Amit and Joshua Livnat are professors at Northwestern University.