In this paper, we examine the workings of internal capital markets in diversified firms that engage in related and unrelated corporate acquisitions. Our evidence indicates that bidders invest outside their core business (diversify) when the cash flows of their core business fall behind those of their non-core lines of business. However, bidders invest inside their core business (i.e., undertake non-diversifying investments) when their core business experiences superior cash flows. We also find that bidders whose core business are in industries with low growth prospects engage in diversifying acquisitions while bidders whose core business are in high growth industries undertake non-diversifying acquisitions. The pre-acquisition evidence, then, suggests that firms tend to diversify when the cash flows and the growth opportunities of their core business are considerably lower than those of their non-core business. Subsequent to acquisitions we find that diversifying bidders continue to allocate financial resources from less profitable business segments (i.e., core business) to more profitable business segments (i.e., non-core business). Given the low profitability of diversifying bidders’ core business, this capital resource allocation suggests that diversification increases do not result in capital allocation inefficiencies. The evidence for non-diversifying bidders, however, supports the existence of “corporate socialism” in the sense that there is transfer of funds from the profitable (core) to the less profitable (non-core) business segments in multi-segment bidders. We find that the capital expenditures of bidders’ non-core business segments rely on both core and non-core cash flows.

We examine whether the protection of trade secrets by restricting the mobility of knowledgeable employees through the adoption of the legal Inevitable Disclosure Doctrine (IDD), an exogenous event, increases the marginal value of corporate cash holdings by reducing the uncertainty of future cash flows, and how that value differs across firms in IDD recognizing and non- recognizing states. We find that the marginal value of cash holdings increases (decreases) significantly in states in which the IDD has (not) been recognized through increases (decreases) in firm value and performance. A battery of robustness tests reveals that the effect of the IDD is more pronounced in firms with high R&D activities. Overall, the evidence shows that the IDD acts as a mechanism that inhibits the mobility of key employees and, thus, reduces the probability of the misappropriation of knowledge-based human capital assets. That is, the IDD creates an opportunity for firms to efficiently use cash to increase firm value - rather than using cash to protect trade secrets from rivals.

Recent theoretical work on mild segmentation suggests that tests of dual listing should be conducted as joint tests: (a) a test of changes in market integration that may affect asset returns through investors portfolio reallocations as the choice set changes, and (b) a test of changing risk premium/information effects. Previous empirical studies on common stocks have been unable to identify significant positive abnormal returns associated with international listing. However, such studies have not formally tested for changes in market integration through time. In addition, they have not examined announcement dates, which should be the focal point in testing for valuation effects. Unlike previous studies, our analysis concentrates on both the period surrounding the earliest public announcements by Canadian companies of their intentions to seek a US listing for their common shares on the NYSE, AMEX, or NASDAQ as well as the date of US listing during the period 1985–96. This period encompasses significant changes in the regulatory environment which might be perceived to enhance the integration of the two markets. Relying on a conditional asset pricing model subject to time-varying volatility, the results of this study fail to support the view that market integration has increased between the Canadian and US stock markets over the 1985–96 period. The significantly positive announcement effects of Canadian stock listings in the US stock market are consistent with the view that the two markets remain mildly segmented despite the elimination of several institutional changes that should have enhanced capital market integration between the two stock markets. Our evidence also implies that firms operating in mildly segmented capital markets can attain a lower risk premium through international stock listings.

Previous work on the pricing of exchange-rate risk has primarily focused on US firms and, surprisingly, found stock returns were not significantly affected by exchange-rate fluctuations. In this paper we conduct an in-depth investigation that examines whether exchange-rate risk is priced in the equity market of Japan using an intertemporal asset pricing testing procedure that allows risk premia to change through time in response to changes in macroeconomic conditions. Our multiperiod asset pricing tests show that the foreign exchange-rate risk premium is a significant component of Japanese stock returns. Specifically, the results suggest that currency-risk exposure commands a significant risk premium for multinationals and high-exporting Japanese firms. The currency-risk factor is found to be less influential in explaining the behavior of average returns for low-exporting and domestic firms. However, it is shown to exhibit large return volatility that is likely to be perceived by investors, who wish to control portfolio risk, as an important underlying source of risk. Furthermore, Japanese stock returns are found to be related to the relative distress and size factors above and beyond the covariation explained by the currency-risk factor.

This study presents a theoretical model that links chief executive officer (CEO) overconfidence to the value loss of corporate diversification. Consistent with the model's prediction, the findings show that diversified firms run by overconfident CEOs experience value loss compared to diversified firms run by their rational counterparts. Empirically, the value loss is economically significant and ranges between 12.5% and 14.1%. In addition, the model predicts heightened corporate refocusing activity by overconfident CEOs who pursued diversified investments in the past once realized returns fail to match initial expectations. The empirical odds of corporate refocusing decisions are 67% to 98% higher when past diversifications are undertaken by overconfident rather than rational CEOs. Another prediction of the model is that overconfident CEOs exhibit preference for diversified investments, especially in the presence of ample internal funds. This prediction is also strongly supported by the data. Overall, this study proposes CEO overconfidence as a unified and consistent explanation of why firms pursue value-destructive corporate diversification policies and later adopt refocusing policies aiming to restore value.