Charles A. Dice Center for Research in Financial Economics

Diversification, Productivity, and Financial Constraints:
Empirical Evidence from the US Electric Utility Industry

We examine the real effects of parent firm diversification on their electric utility operating companies over the period, 1990-2003.  Since electric utility operating companies produce a single homogenous product, we can better measure their Total Factor Productivity and make valid comparisons of productivity across firms. We find that, consistent with a diversification discount, greater parent diversification is associated with lower productivity across electric utility operating companies. However, the productivity of the electric utility operating companies improves with greater parent diversification over time.  Diversification appears to provide an alternative channel to divert investment dollars away from overinvestment in the core electric business. Finally, we find that the improvement in the productivity of the electric utility operating companies from greater parent firm diversification over time is limited to financially constrained firms.  This suggests that when managers have no resources to waste, it is more likely that any diversification activities are carefully planned and undertaken for strategic purposes that can help to increase productivity of the core business.