Effect of Diversification Strategy, Leverage and IOS on Multi Segment Corporate Performance in Indonesia

Abstract

This study examines the impact of diversification strategies, the level of use of debt (leverage) and the investment opportunity set (IOS) on the performance of diversified firms. Performance measurements using excess value (a proxy of market performance) and ROA (a proxy of accounting performance) is also discussed in this paper. This research includes measurement of diversification using the Herfindahl index and based on the number of corporate segments. The diversification strategies in this study are divided into 2 groups, namely, related and unrelated diversification of the firm’s core business. The samples of this study are taken from all the multi-segment companies listed in the Indonesia Stock Exchange (IDX) for an 11-year period from 2000 to 2010 and using panel data with a number of observations from 120 multi-segment companies (1,320 firm years). The test results indicate a negative effect of the implementation of diversification strategy on the firm’s performance. The smaller the number of segments related to the core business, the better the market performance and as well as the accounting performance. The study also indicates that there is a quadratic relationship between diversification strategy and performance, i.e. increasing the number of segments, after reaching a certain optimum point, will discount the value of the company.

DOI: 10.5901/mjss.2015.v6n5s5p157