This study investigates the role of debt as an internal governance mechanism that can be employed by companies to curb agency conflicts and discourage managers from value-destroying diversification. Using a panel of U.S. firms, we find that leverage positively moderates the effect of diversification on a firm's value. We confirm that such an effect stems from the monitoring role of debt, which fosters efficiency in investments across segments and discourages cross-subsidization. Our investigation goes a step further by delving into the disciplinary role of debt and rationalizing certain scenarios that determine whether the effect of debt on the diversification-value relationship is stronger or weaker. We find such a moderating effect proves more beneficial for unrelated diversified companies and for firms with lower investment opportunities. However, the benefits of debt weaken in the presence of an alternative monitoring device (concentrated ownership), and when debt allocation becomes discretionary in highly diversified companies.

This study analyses whether the effect of corporate diversification on a firm's market value depends on how this strategy is implemented. According to the real options approach, two opposite diversification strategies may be implemented: one based on fully exercising available options (assets-in-place diversification) and the other aimed at seeding new opportunities for future growth in multiple businesses (growth options diversification). We propose an index to measure these two diversification patterns and we explore their impact on firm market value for a sample of U.S. firms during 1998–2014. We find that as a firm's diversification strategy shifts towards a growth options pattern, it becomes a more value-enhancing strategy.