Consequences Of Corporate Refocusing: Ex Ante Evidence

During the 1980s, many diversified firms reduced their diversification by refocusing on their core businesses. To examine whether this refocusing created market value for the companies involved, 45 refocusing announcements from 1980-1988 were analyzed. Market model parameters for each firm over the period from 270 to 90 days prior to the refocusing announcement were calculated using daily company returns and equally weighted market returns from the CRSP tapes. It was shown that refocusing announcements are associated with significant, positive abnormal returns, implying that firm diversification levels prior to refocusing were higher than optimal. Reductions in diversification were found to be associated with value creation, implying that there is a limit to how much a firm can diversify - if a firm goes beyond this limit, its market value will suffer. Refocusing can be viewed as an adjustment process that brings overdiversified firms closer to their optimal limits and thus improves their efficiency.