A review of Bens, D. A. and S. J. Monahan, 2004, “Disclosure Quality and the Excess Value of Diversification,” Journal of Accounting Research 42, 691-730.
I. Research question and its importance
Drawing on the literatures of corporate finance and accounting, this paper investigates the relationship between disclosure quality (as measured by two proxies: AIMR survey and degree of segment disaggregation in disclosure) and excess value of diversification (measured by two proxies: excess value by Berger and Ofek (1995) and efficient capital transfer by Billet and Mauer (2003)). There are three reasons the topic is important. First, a literature gap in the cost of capital for diversified firm is yet to be reconciled. On one hand, multi-segment firm enjoys internal capital market as well as economies of scope. On the other hand, higher information complexity induces information asymmetry between its managers and shareholders. This paper aims to fill this gap. Second, while many prior researches focus on the cost of capital per se, this paper instead bases its analyses on excess value that offers a more value-relevant measure of diversification. Third, this paper distinguishes itself by offering cross-sectional comparison of multi-segment and single-segment firms which was lacking in previous works.
II. Method, finding, and limitation
The sample consists of U.S. firms from 1980 to 1996. Pooled time-series with annual fixed effect and Fama and MacBeth regression were employed to analyse the data. They show positive relationship between disclosure quality and excess value if proxied by BO definition. But the result is mixed if proxied by the value of investment. An alternative explanation pertains that firm deliberately increases its disclosure quality in order to finance its diversification investment with lower cost of capital. This endogeneity issue persists and is difficult to address unless an experiment became possible. In a similar fashion, latent variable such as macroeconomic factor (i.e., decreasing cost of capital) that might increase diversification while decreasing disclosure quality is not completely ruled out.
III. Future research
Future works may exploit exogenous shocks to make robust inference. For instance, the collapse of Soviet Union in 1989 (in milieu of the dataset utilized by this paper) warrants an opportune diversification event open up for U.S. firms, which can be used to test whether diversification leads to better disclosure quality. Conversely, IFRS requires the combining of two firms (i.e., diversification investment) to be explicitly reported as acquirer and acquiree rather than just merger (as it was under GAAP), hence enhances disclosure quality. Researcher might exploit this event and observe the change in excess value subsequent to the IFRS adoption. Both shocks might aide in addressing the endogeneity issue mentioned above. One trivial yet more technical suggestion to the authors points to the potential selection bias in its change analyses (i.e., E.q. (5)). Namely, using AIMR survey to measure sustained TDS measure risks that a firm being included in the survey for four consecutive years is different in nature comparing to other firms in the market, such as higher ROA, etc. All the rest is logical.