The Impact of Diversification on Firm Performance and Risk: An Empirical Evidence

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1 International Research Journal of Finance and Economics ISSN Issue 35 (2010) EuroJournals Publishing, Inc The Impact of Diversification on Firm Performance and Risk: An Empirical Evidence Ines Kahloul Corresponding Author, Department of Finance Higher Institute of Management 41, rue de la liberté, Bouchoucha-2000 Bardo Slaheddine Hallara Department of Finance, Higher Institute of Management 41, rue de la liberté, Bouchoucha-2000 Bardo Abstract The aim of this paper is to analyse and to test the influence of the activity perimeter on the firm performance and risk. The empirical tests follow two stages, a first one consisting in studying the diversity evolution of a sample of largest French groups. The second consists in studying the nature of the relationship linking the diversification level to the firm s risk and performance. A longitudinal study enabled us to confirm the movement of corporate refocusing from both Herfindahl and Entropy indices. A multivariate analysis is included with dynamic panel data and finally a non monotonous relationship diversification-performance, diversification-risk are checked. Keywords: Diversification, refocusing, performance, risk 1. Introduction The announcements and the practices of firms are worked today, by two roads in dialectic tension: the financial road which focuses on the concentration as a strategy of risk mastery and the durable road that privileges the diversification to distribute the risk (Martinet, 2006). The diversification strategy constitutes a field of investigation for management risk researches. The financial road focusing on short term horizons incites to a concentration of the risk and a standardization of the growth models. Whereas the durable road rather oriented on long term horizons, privileges the diversification strategy by a distribution of the risk. The aim is to maintain and to develop the value creation potential with regard to the different parts. Thus, several studies were interested to the impact of the strategy developed by the firm on the performance. The theme of the diversification-performance relation, probably one of the most studied in the literature, is yet far from being exhausted (Palish and al, 2000). Since the 70 th the academic research tried to check the relation between diversification strategy and firm performance. Nowadays, the problematic of the firm activity perimeter evolution is an interesting subject so much in industrial economy, in strategy or in finance. The majority of theoretical and empirical works are characterized by a plurality in the sense that they can be opposite and have changed more and more rapidly. Besides, the strategic study exam

2 International Research Journal of Finance and Economics - Issue 35 (2010) 151 achieved on the theme of diversification reveals that most of these studies ignored the risk aspect, as well as the managerial objectives pursued. The motivation of reduction of risk by diversification (Amihud and Lev, 1981; Wright and al, 2007), highlighted in the literature, contributes largely to explain our choice to integrate the notion of risk in our present study. This is a post motivation letting us to investigate the mechanism of diversification of the firm in the French context to better seize its particularities. The present work is interested to the double impact of the diversification on performance and risk. In Lang and Stulz (1994) and Berger and Ofek (1999), an objective continuous measure of the strategic diversity of the firm based on the Herfindahl index has been used. In the present work, we compute the Entropy index in order to confront the results inherent to the two indices and to test the consistency of the analysis. Otherwise, most studies are concentrated on cross-section analyses. Differently, our work uses a longitudinal data from a sample composed of 69 large French firms quoted on the period of , in order to analyze the firm activity perimeter evolution effect on its level of risk and performance in a dynamic prospect. The empirical survey conducted on the French context is going to provide answers associated to double objectives: retracing the evolution of the diversity of the large French groups and testing the main current theoretical validity on the relation between diversification and performance, with the integration of risk. The present work is organised as follows: In Section 2, the hypothesis and the variables are presented. In section 3, a description of French firms selection is provided, the research methodology is developed and data analysis is conducted. Furthermore, a synthesis of founded results concerning the operations of refocusing and strategic diversification in France and their impact on the performance and on the risk of the firm is provided. We conclude afterwards. We just recall before going one developing the paper that the present work is inspired from our work Kahloul (2008) which was presented as a conference paper in the 5th colloquium of the ADERSE held in Grenoble, France, January 10-11, However, there are some minor modifications carried on the conference paper. The sample size is reduced from 76 firms for the conference paper to 69 in the present study. This is just for estetique of the paper while a complete study is already provided in our paper Kahloul (2008). Next, some variables are added. These are the Return on Assets (ROA), which is retained to assess the level of performance of the firm. It indicates that the company has generated as earnings at the end of its investments. Next, the Growth of the firm (GROWTH) which is one of the explanatory factors the most important of the performance of firms. These variables are mentioned but not included in the empirical study in the conference paper. We added them for a complete empirical study here. 2. Hypothesis and Variables A large and a well developed literature were interested to the survey of the gains and costs of the diversification strategy (Comment and Jarrel (1995), Denis and al (1997), Rajan and al (1998), Rajan and Zingales (2000), Bhagat and al (1999), Campa and al (2002)). Despite a general agreement that seems to be observed concerning the negative impact of the diversification strategy on the performance of the firm (Lang and Stulz (1994), Berger and Ofek (1995), Serveas (1996), Lins and Serveas (1999)), mitigated results are observed in other studies (Bodnar and al (1997), Stein (1997), Miller (2006)). A large number of academic works relatively to the French context has tested this relation. The reduced number of French studies (Perdreau (1998), Godard (1996), Maurer (2003)) does not allow us to decide on the nature of this relationship and therefore justifies new tests. Based on the developments of the literature, several hypotheses are developed. The first hypothesis is about the relationship diversification-performance. It is stated as H 1: The strategy of diversification presents a negative impact on the performance of the firm.

3 152 International Research Journal of Finance and Economics - Issue 35 (2010) However, a possibility of questioning of the linear nature of this relationship is observed (Grant and al (1988), Hoskisson and Hitt (1990), Denis and al (1997)). A second hypothesis dealing already with the same relationship is the following. H2: A U-shaped curvilinear relationship exists between diversification and performance. Next, a main object is to contribute to the understanding of the diversification-performance relation while integrating a primordial dimension in the analysis about the risk and its components. The following risk relationship can be hypothesized. H3: The diversification is associated to a reduction of the firm risk. Based on the reconsideration of the implicit hypotheses of Amihud and Lev (1981) on the managerial behaviour, especially on the risk aversion, and on the behavioural perspective developed by Wiseman and Gomez-Mejia (1998), hypothesis H3 is refined next to the following. H3': Performant firms satisfy the presence of a negative relation between diversification and risk. This relation is not observable, or less strong, for the low performant firms. The tests include variables of performance, diversification and risk and some control variables. The performance: Two performance measures are identified based on accounting and stock market data: Tobin s Q and Return on Assets. Tobin s Q (Q): The Tobin s Q is computed as the ratio of Stock capitalization added to financial debts on Total assets. That is Stock Capitalization + Financial Debts Q = Total Assets Return on Assets (ROA): The ROA is the ratio of the operating result (current income before tax) and the assets of the company. i.e ROA Operating Re sult = Total Assets The Diversification Strategy (H,E): The measure of the diversification of the firm has been valued from two continuous measures: the Herfindahl index and the Entropy index. The Herfindhal index is computed as H = n i = 1 2 P i where n is the number of the firm s activities and Pi is the relative weight of each activity evaluated as the proportion of the sale xi of the activity i of a firm. The Entropy index is defined by n E = P ln P i = 1 i i The Entropy index varies therefore oppositely to the Herfindhal one. The risk (ETYP): The total risk of the firm is estimated from the market data. It is appreciated by the standard deviation of stock returns. The specific component corresponds to the standard deviation of residues of the right of the market of each title. The market risk or the systematic risk is measured through the variance of the market multiplied by the beta of the firm. The size of the firm (SIZE): It is essential to control the size of the firm sample that is supposed to act on the performance. We kept as variable of control the size of every firm measured by the logarithm of the total asset of the group. The debt (DEBT): The variable of the debt is measured as the ratio of the total debts and the shareholders equity.

4 International Research Journal of Finance and Economics - Issue 35 (2010) 153 The Growth of the firm (GROWTH): The growth of the company is one of the explanatory factors the most important of the performance of firms. This variable is measured by the average variation of the turnover on the reporting period. That is GROWTH = Salesn - Sales Sales n -1 n-1 3. Empirical Results and Discussions As it is mentioned in the introduction, the sample is composed of 69 non-financial French firms quoted on the period The data are extracted from the Thomson Financial basis. The choice of the sample is motivated by the following criteria: (1) important size; the sales exceeded in general 100 M on the set of the 11 years (Palard, 2006). (2) Total period , (3) Industrial activity; elimination of the firms whose main activity corresponds to the sectors Banking-Finance-Insurance. (4) A quotation historic being sufficient on the whole period of the survey. The diversity of companies activities was also considered at the level of the groups which eliminates the subsidiaries listed of these groups. The choice is also related to the study of the diversification behaviour due to the biggest French industrial groups quoted and by some constraints related to data availability. The methodology for analyzing data is based on univariate and multivariate analysis. In the first, the Herfindahl and the Entropy indices are based on the distribution of the sales by activity which allows the definition of the diversification strategy level for each firm. The multivariate analysis allows highlighting the firm activity perimeter evolution effect on the performance and on the risk of the firm. The data being in both time series and cross sectional, we have thus made regressions using a panel data. Moreover, in a methodological point of view, one of the assets of this paper is to study the evolution of activities perimeters of French firms listed from the panel data. The double crosssectional and temporal dimension data increases the number of comments and improves the quality of estimators. Table 1 hereafter resumes the descriptive statistics of the variables on the whole period ( ): mean, maximum, minimum and standard deviation. The diversification variable is measured by two indices: the Herfindhal index (HERF) and the Entropy index (ENTROP) which measure the concentration of the sales by activities. The performance is evaluated by the Tobin s Q (Q) and the Return on Assets (ROA). The risk is measured by the standard deviation of the return equity (ETYP). The log of total assets measures the size of the firm (SIZE). The (DEBT) variable corresponding to the total debt/total equity, presents the debt of the firm. The growth (EVOLCA) is measured by the variation of the turnover of the company. The number of observation is 759. Table 1: Descriptive Statistics ENTROP HERF Q ROA ETYP SIZE EVOLCA DEBT Mean Maximum Minimum Standard deviation Observations Table 2 below provides the correlation matrix of all endogenous and exogenous tested variables.

5 154 International Research Journal of Finance and Economics - Issue 35 (2010) Table 2: Matrix of correlations ENTROP HERF Q ROA ENDT SIZE EVOLCA ETYP ENTROP HERF Q ROA ENDT SIZE EVOLCA ETYP We observe that the level of diversity of firms in the sample varies between two extremes thresholds: a significant level of diversification and a low level akin to a strategy of specialisation, as show the minimum and maximum values of the Entropy and Herfindhal indices. Beyond these extremes, the middle Entropy index shows a level of diversification fairly high for the studies firms. This finding is compatible with the large size of firms in our sample. The return on assets presents an average less than 1. While, the average value of Tobin s Q is greater than 1. We agree for this last value the majority of the work having recourse to this measure and which present an average of the Q means and median near 1. The measures stock market performances seem to indicate in average a future creation value for the firms considered. The average debt of firms is high. Furthermore, the amplitude of variation is as strong as evidenced by the standard deviation. The similar observation is advanced for the growth variable Study of the Diversity of the French Companies ( ) The evolution of the diversification strategy of 69 French industrial groups has been evaluated by using two measures: the Herfindahl index and the Entropy index based on the distribution of sales. The Entropy and Herfindhal indices are evaluated for each year of the period of The idea behind this synthesis is to confront the result of the two-dimensional of the two indices and thus to ensure the coherence of the analysis. In order to more understand the evolution of the diversity level of the French groups sample, we started by computing the average Entropy and Herfindhal indices. Table 3 incorporates these data. Table 3: Evolution of the mean of Entropy and Herfindhal indices H 0, , , , , , , , , , ,49736 E 0, , , , , , , , , , ,95691 The evolution of the mean Herfindhal index shows that the index is slightly decreasing until 1999 and it starts to increase from Correspondingly, the Entropy index has experienced a change in direction. Therefore, we may deduce from these results, that the evolution of the portfolio of activities of the major French groups quoted can be characterized by two phases. The analysis of the evolution of means indices shows that the evolution of the diversity is characterized by a low magnitude during the first period, but from 2000, the tendency to refocusing seems to emerge clearly. This is also shown in Figure 1 and Figure 2 hereafter. More precisely, Figure 1 shows that Entropy index has experienced a downward trend from This stipulates a decline in the level of diversification of groups of the sample. Figure 2 shows an increase of the Herfindhal index from This stipulates a tendency to refocusing of the groups and therefore a decline in the level of diversification.

6 International Research Journal of Finance and Economics - Issue 35 (2010) 155 Figure 1: Evolution of the Entropy index Evolution of the entropy index based on sales 0,959 0,9585 Mean entropy index 0,958 0,9575 0,957 0,9565 entropy index/sales 0, Year Figure 2: Evolution of the Herfindhal index Evolution of Herfindhal index based on sales Mean Herfindhal index 0, ,4975 0, ,4974 0, ,4973 0, ,4972 0, Year Herfindhal index/sales These results indicate that the portfolio activity evolution of major groups quoted in France can be marked by two successive phases. A first one characterized by a degree of stability in the evolution of the Herfindhal index downward and a slight increase in the Entropy index to the increase, which shows a stability in the diversification strategy. A second phase corresponding to an increase of the Herfindhal index and to a decrease of the Entropy one shows the trend of groups to reduce their level of diversity which is equivalent to a movement of strategic refocusing. For more precision, and to be able to pursuit the observed trend, we have held to analyze the evolution of the diversity during the periods, , and The choice of such decomposition is based in one hand, on the results due to the analysis of the evolution of the calculated mean indices. On the other hand on our motivation to compare our result to the results of previous works especially those held on the 90 th and to observe the diversity level evolution of French groups up to a recent period. We considered the number of firms for which the Herfindhal index evaluated in the rising, in the decline or remained stable between extreme years of each sub-period and the overall period 1995-

7 156 International Research Journal of Finance and Economics - Issue 35 (2010) Similar computations have been carried out as with the Entropy index. The results are provided in Table 4 and Table 5 below. Table 4: Diversity evolution of French groups ( ) with Herfindhal index H increasing H decreasing H stable* Total Table 5: Diversity evolution of French groups ( ) with Entropy index E rising E in decline E stable* Total The star (*) means that when the rate of variation is less than 1%, the evolution of the index is considered stable Let us examine more the results shown in the tables 4 and 5. The main points to be well noticed are resumed to the following Table 4 shows that Herfindahl index has a slight tendency to increase more than to decrease along the period Besides, the Entropy index seems to decline slightly more than being upwards. During this period a slight trend to the refocusing seems to emerge but not clearly predominant. The number of groups with sales in dispersion is close to that of groups with sales in concentration. The period of provides a clearer idea on the observed trend. The slight increased tendency observed during the previous period is strengthened during the present one. The diversification of groups has decreased in the period compared to the previous one. The number of Herfindhal index in decline is reduced from 27 during to 16 for Correspondingly, the Entropy index has an opposed development as shown in Table 5. During the period , the number of decreased Entropy index being equal to 48 is higher than that increased which equals to 19. The trend to the refocusing, which is reflected by the concentration on a reduced number of activities, emerges allowing a slow diversification movement during , to leave a movement of tightening of activities. The same observation is observed for the entire period , which is checked through the evolution of the Herfindhal index (68% rising against 23% in decline) and of the Entropy index (61% in decline against 36% rising). It seems that firms tend to concentrate on a single activity. They may also submit a non-egalitarian distribution of sales between several activities, only an activity in this case would present a significant part of sales. In both cases, the general trend observed is a tightening of activities, which has worsened during the time. It emerges from this analysis, that the tendency to promote a sector constitutes the most important characteristic. Because of these findings, we can conclude to the predominance of the movement of refocusing during the period for the majority of French groups. However, although this number is reduced compared to the previous period, a number of groups continue to diversify. Our concluding suggestions can find their explanation in the contribution of the internal and external markets theory, which considers the financial function of groups as the places of allocation of capital alternative to the financial "external" markets. The decline in the level of diversity may be due

8 International Research Journal of Finance and Economics - Issue 35 (2010) 157 to the financial role of shareholders in the conglomerates firms (internal market) which has lost its interest with the active development of financial markets. Declining level of diversity can be explained also by a constraint of performance and the need to seek a strong position on the competitive markets Diversification and company value In this section we conduct multivariate analyses of the diversification effect on the performance variables. We have provided after the conceptual development a possible curvilinear relationship between diversification and performance. The highlighting of this relationship should take into account other variables such as size, debt, growth and risk. To test the possible presence of a correlation or a defect of specification, we have applied the well-known Hausman test. The regressions are carried out according to the technique of least squares taking into account a possible heteroscedasticity of residues. Many regressions have been carried out integrating different performance and diversification measures. The data collected on 69 French groups quoted has allowed us to estimate the following econometrical model of panel data in considering the existence of individual fixed effects between firms: PERF (Q, ROA) it = α 0 1DIVER it 2SIZE it 3DEBT it 4E V O L C A it 5E T Y P + ε it. Table 6 shows the regressions using as an explained variable the Tobin s Q and the ROA. The results of our empirical examination provide finer insights into the debate concerning the impact of diversification on performance. Table 6: Effects of diversification on performance (Q,ROA) Dependent Variables (1) (2) Independent variables Q ROA Constant Entrop E2 E3 Size Debt Evolca *** Etyp (-4.80) F 1.81* 3.92*** Adj. R N *** *** 0.801** ** *** *** * 0.082** ** (5.13) (-2.71) (2.18) (-1.90) (-3.10) (0.56) (1.06) (2.81) (-1.92) (1.99) (-1.92) (-1.14) (0.79) (-0.71) The numbers in the parenthesis are robust t-statistics. The stars *, **, and *** indicate statistical significance at the 10%, 5% and 1% levels respectively. Regressions of the performance measures (Q,ROA) on the diversification E, E2 and E3 correspond respectively to the square and the cube of the variable E. The control variables are: the size (SIZE) measured by the logarithm of the total assets, the debt evaluated by the relationship between total debts and total equity, the growth (Evolca) measured by the company turnover variation and

9 158 International Research Journal of Finance and Economics - Issue 35 (2010) finally the risk (Etyp) measured by the standard company share returns deviation. The number of observations is fixed to N=759 for each regression. The results of the linear regressions display no significant result. The impact of the diversification on the performance is certainly negative but not significant. It is even with the Herfindhal index. These results not satisfying the assumption H1 as we have suggested, encourages us to test the non linearity of this relationship. By introducing the square and the cube of the Entropy variable E in the regressions, a relationship in three stages is observed. We noticed that the performance decreases in a first step (the coefficient of the Entropy E is negative and significant), it then increases with the level of diversification with an entropic measure of 1.19 with Q and 1.07 with ROA. The coefficient of E2 is positive and significant. The performance decreases again beyond a certain threshold with an entropic measure of 1.26 with Q and 1.11 with ROA. The coefficient of E3 is negative and significant. We recall finally that we have introduced the risk as a control variable only in the regressions containing the accountant s measures of performance ROA. In fact, the Tobin s Q is implicitly adjusted to the risk. Due to Charreaux (1997), it is evaluated from the values market which takes account of risk premiums requested by the investors. The first negative phase observed can be explained by expenditures incurred for diversifying the firm, which may affect its growth opportunities. Besides, the financing of the diversification can induce a reduction in the expenditure in research and development and following a decrease of innovation, which may affect the performance of the company. For the second phase, the positive effect of the diversification on the performance prevails over the negative effect already observed. The diversification situated in an intermediate level begins to generate value for the company. An intermediate level of diversification appears to increase profits and gains in terms of performance. This phase can respond to that where the benefits of diversification are still lower than the linked costs. According to Markides (1992), these benefits can be related to the various synergies that it can present and to the gains of exploitation of existing resources. We note, however, that the negative effect of the diversification level on the performance is observed of new beyond a certain threshold of diversification. Such a negative impact can be justified by the costs of diversification, which go beyond a fairly high level of diversification, its benefits. The deterioration in the level of performance is observed when the additional costs exceed the profits in terms of efficiency (Jones and Hill (1988) and Markides (1992)). The existence of limit to the diversification is explained in terms of marginal profits and costs associated with such a strategy. The conclusion, which we end up is that beyond the point of intersection between the two curves of costs and benefits, the diversification entails a reduction of performance. Each firm has a point of equilibrium which is specific and which corresponds to the intersection between marginal costs and marginal benefits. This point can be function of the resources available to the company, to its environment, its type of diversification, the capacities and skills of its management team, etc. The size presents a negative effect on the performance measures. This can be interpreted by the fact that throughout their growth, the companies exhaust their profitable investment opportunities. The debt of the firm presents also a negative but a non-significant impact. We can emphasize that the companies very indebted would have exhausted in part, their opportunities of investments Diversification and the Company's Risk The regressions carried out joint the measures of the risk to the diversification firm variables. The next model has been estimated considering the existence of random effects between firms: RISK it = α 0 1DIVER it 2SIZE it 3DEBT it + ε it. Table 7 resumed the regressions explaining the level of risk of the company by its level of diversity. The test of linear model between the total risk and the diversification do not supply significant result. The same thing is observed for the specific risk and the diversification. However, a positive and significant linear relationship is satisfied for the diversification, when the systematic risk is introduced

10 International Research Journal of Finance and Economics - Issue 35 (2010) 159 as explained variable (regressions 2 and 3). A reduced level of diversification reduced the systematic risk, while an increase in the level of diversification increased it. The same result is obtained by introducing the Herfindhal index as dependent variable. The interest of this estimate is to understand the effect of the diversification strategy on the market value of the firms. Our result joined the famous result of Montgomery and Singh (1984). We thus conclude that the diversified firms increase the market risk and these firms tend to have an important financial leverage. The first regression takes the standard deviation of shares returns, which corresponds to total risk of the firm, in explanatory variable. A non-linear relationship is checked. At a low level of diversification, the total risk decreases, increases then for a level of diversification located between 1.02 and 1.06 (entropic measure), decreases after, beyond 1.06 The assumption H3, which suggests a negative relationship between diversification and risk, is corroborated at different levels of diversification. Table 7: Effects of diversification on firm risk Dependent variables Global sample: 69 groups Independent variables (1) (2) (3) (4) Totrisk Systrisk Systrisk Spefrisk Constant 0.009** 0.001*** *** 0.009** (2.29) (2.83) (4.30) (2.14) H *** (-2.69) E * *** * (-1.71) (2.49) (-1.74) E ** 0.019** (2.26) (2.26) E ** ** (-2.29) (-2.29) Size * * (-0.52) (-1.68) (-1.65) (-0.35) Debt 0.001*** *** *** 0.001*** (3.83) (2.88) (2.94) (3.65) Wald 26.04*** 14.84*** 15.89*** 24.03*** Adj. R N The regression 4 considers the specific risk as an explained variable. The relation is significant when it is non-linear. The relationship varies according three levels. The mean variation of the specific risk follows that of the total risk of regression 1. It decreases in a first step, increases then to a threshold 1.22 for diversification, and decreases beyond Our findings join partially those of Lubatkin and Chatterjee (1994) yielding a minimal risk for a reduced diversification strategy. In the cited reference, an empirical analysis shows that the limited diversification strategies allow a decline in the risk, while the large diversification strategies lead to an increase since they do not allow qualifying for synergy. We thus conclude that the manager can find a possible satisfaction in the reduction of the specific and total risks (Amihud and Lev (1981)). We can note however, that our results show that the hypothesis of reduction of risk due to Amihud and Lev (1981) can not be applied for all levels of diversification. Next, we have conducted the amendment of the assumption H3 and we borrowed the logic of Wiseman and Gomez (1998) as a part of a behavioral perspective and which suggests that the behavior of the risk reduction by diversification could be observed for the most efficient firms. Thus, we have resumed the same regressions retaining firms with a Tobin s Q exceeding the median of the sample. We thus obtained a reduced sample consisting of 34 groups. The main results are shown in the Table 8.

11 160 International Research Journal of Finance and Economics - Issue 35 (2010) Table 8: Effects of diversification on firm risk Dependent variables Reduced sample 34 groups Independent (1) (2) (3) variables Totrisk Systrisk Spefrisk Constant *** (0.06) (2.36) (0.11) E 0.004** * 0.004** (2.21) (1.60) (2.10) Size (0.08) (2.04) (0.26) Debt 0.004*** *** 0.003*** (6.11) (4.87) (5.70) Wald 46.31*** 31.5*** 40.78*** Adj. R N It shows regressions of the risk and its components Totrisk, systrisk and Spefrisk on the diversification E. The number of observations is N=374 for each regression. We noticed that there is a positive relationship between diversification and risk and its components. An increase of the diversity can therefore increase the risk of the firm. The assumption of risk reduction does not occur on our reduced sample. This may explain further the decline of the diversification for the majority of groups. Besides, we can explain our present result by the fact that the Tobin s Q is considered as a measure of the risk aversion, and then it appears normal that on our reduced sample having a Tobin s Q higher than the median, that we are seeing risk-taking. We expect a positive impact of the leverage on the risk of the firm. This relationship is observed for all regressions: a higher leverage increases the average rate of return on equity, but also their volatility. The effect of the size is positive but not significant. 4. Conclusion In this paper, we sought to measure and to explain the evolution of the strategic business perimeter of the French firms on a sample of 69 large industrial quoted groups. The results highlight that the strategic trend followed by the French firms is equivalent, primarily between 2000 and 2005 to a refocusing strategy. The decline of diversity observed on our sample suggests that the managers limit their strategy to reduce their employment risk, away the firm of risks related to a large diversification. In a second stage, building on theoretical developments and empirical results in strategy and finance, we sought to study the relationship diversification/performance and diversification/risk. We noticed a non-linear relationship diversification/performance. A relationship diversification/performance in three stages (ROA and Q) is checked. It shows that an intermediate zone between a specialization and wideranging diversification corresponds to the area of performance and value creation. The existence of an optimum of diversification that may vary between firms, can explain the development of the refocusing for some of them and the continuation of the diversification for some others. This result seems to plead in favor of an intermediary strategy between the diversification and specialization, which could respond to the objective of durable development for the company. To complete the study on the link diversification/performance, we conducted regressions on the impact of diversification on the risk and its components. The results show a non-linear relationship between total risk, its specific component and the diversification. A positive linear and significant relationship is rather checked between diversification and systematic risk. We join the result of Amihud and Lev (1981): If the managers find a possible satisfaction in the reduction of the specific and total risks, the shareholders may suffer from a too large diversification with constant profitability. This result can be compatible with any opportunistic manager behaviour. Besides, our result shows that

12 International Research Journal of Finance and Economics - Issue 35 (2010) 161 the reduction risk by diversification hypothesis is not checked for all levels of diversification. Based on behavioural perspective we have resumed the same regressions on a small sample presenting the most efficient firms. The risk and its components increased with the level of diversification. This can justify the decline of the level of diversification on our sample. The consequences observed in the diversification on the risk and on the performance contribute to explain therefore, the evolution of this strategy during the time. Among other, the mechanisms of control and the weight of shareholders within the firm, could justify the trend to the refocusing of the majority of firms, observed on our total sample. In extending these findings relating to diversification, performance and risk, it could be quite important to explore the role of mechanism of Governance in the determination of the diversification strategy. In particular, the ownership structure could potentially moderate the relations between diversification-performance and diversification-risk. It is quite possible that the nature of ownership could be salient to understanding the diversification, performance and risk relationships. References [1] Amihud Y. and Lev B. (1981), Risk reduction as a managerial motive for conglomerate mergers. Bell Journal of Economics 12(2), [2] Berger P. G and Ofek E. (1995), Diversification s effect on firm value. Journal of Financial Economics 37(1), [3] Berger P. and Ofek E. (1999), Causes and effects of corporate refocusing programs. Review of Financial Studies 12(2), [4] Bodnar G. M., Tang C. and Weintrop J. (1997), Both sides of corporate diversification: The value impacts of global and industrial diversification. Working paper 6224, NBER. [5] Campa J.-M. and Kedia S. (2002), Explaining the diversification discount. The Journal of Finance 57(4), [6] Charreaux G. (1997), Le gouvernement des entreprises, théories et faits. Economica, Paris, 540. [7] Chatterjee S. and Blocher J. D. (1992), Measurement of firm diversification: is it robust?. The Academy of Management Journal 35(4), [8] Chakrabarti A., Singh K. and Mahmood I. (2007), Diversification and performance: Evidence from East Asian firms. Strategic Management Journal 28(2), [9] Comment R. and Jarrell A. (1995), Corporate Focus and Stock Returns. Journal of Financial Economics 37(1), [10] Delios A. and Wu Z. J. (2005), Legal Person Ownership, Diversification Strategy and Firm Profitability in China. Journal of Management and Governance 9(2), [11] Denis, D. J., D. K. Denis and Sarin A. (1997), Agency problems, Equity ownership, and Corporate diversification. Journal of Finance 52(1), [12] Grant R. M, Jammine P. and Thomas H. (1988), Diversity, diversification and profitability among British manufacturing companies, Academy of Management Journal 31(4), [13] Hoskisson R. and Turk T. (1990), Corporate Restructuring: Governance and Control Limits of the Internal Capital Market. Academy of Management Review 15(3), [14] Hoskisson R. E., Hitt M. A., Johnson R. A. and Moesel D. D. (1993), Construct validity of an objective (Entropy) categorical measure of diversification strategy. Strategic Management Journal 14(3), [15] Jensen M. C. (1986), Agency costs of free cash flow, corporate finance, and takeovers. American Economic Review 76(2), [16] Jensen M. C and Meckling W. H. (1976), Theory of the firm, managerial behaviour, agency costs and ownership structure. Journal of Financial Economics 3(4),

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