The Diversification Effect on the Heterogeneity of Investor Beliefs

Abstract

In the paper, we study the effect of multiple industry operations on the heterogeneity of investor beliefs. In particular, we compare the levels of heterogeneous beliefs between diversified firms and focused firms. We study the change in the level of heterogeneous beliefs subsequent to diversifying and non-diversifying mergers. We also relate the diversification effect on investors' heterogeneous beliefs to the diversification effect on firm value and ex-post stock returns. We document four findings. First, we find that diversification reduces the level of heterogeneous beliefs on a firm's future prospects. Second, the excess level of heterogeneous beliefs on diversified firms relative to focused firms follows a pattern of mean-reverting. Third, the value of diversified firms increases relative to focused firms with an increase in the diversified firms' excess level of heterogeneous beliefs. Finally, we find that a smaller excess heterogeneity of beliefs on diversified firms is followed by an increase in the diversified firm's ex-post excess values and an increase in their ex-post stock returns. Overall, our results contribute to the understanding about how corporate organization structure affects the heterogeneity of investor beliefs and firm values.