We estimate diversification's effect on firm value by imputing stand-alone values for individual business segments. Comparing the sum of these stand-alone values to the firm's actual value implies a 13% to 15% average value loss from diversification during 1986–1991. The value loss is smaller when the segments of the diversified firm are in the same two-digit SIC code. We find that overinvestment and cross-subsidization contribute to the value loss. The loss is reduced modestly by tax benefits of diversification.

We study the decision to fund R&D through a separate financing organization (an ‘RDFO’) that takes the form of either a limited partnership or a corporation. The RDFO offers tax and financial reporting benefits. As a form of external funding, it also creates moral hazard and adverse selection problems (information costs). Using convertible debt as a comparative form of external funding, we find that debt-related (but not equity-related) financial reporting benefits affect the decision to form RDFOs, the evidence is mixed on whether taxes influence the formation decision, and the information costs of RDFOs restrict their use.