The Effect of Diversification Relatedness on Firm Performance

This paper investigates the relationship between diversification relatedness and firm performance in the U.S. property-liability insurance industry. While prior research has evaluated the effect of diversification on insurer performance, little evidence exists regarding the relation between diversification strategy and performance for diversified firms. Theory suggests that potential costs and benefits are associated with related and unrelated forms of diversification and that these can vary along the relatedness continuum. We test for the net effect of diversification strategy and find that relatedness negatively impacts accounting performance. This relatedness penalty is robust to corrections for potential endogeneity bias, it exists for newly diversifying firms, and it has a differential effect on stock and mutual insurers. Finally, we find that related diversification is largely responsible for the diversification penalty found in prior research while unrelated diversification has no relation to accounting performance.