Diversification strategy and earnings informativeness for security valuation

Abstract

This paper examines the association between two types of diversification, including industrial diversification and global diversification, and the informational role of earnings for equity valuation. Using a sample of listed firms in Taiwan, the results show that, the incremental effect of industrial diversification on the association between stock return and future earnings is negative, whereas the incremental effect of global diversification on this association is positive. In addition, the relation between current earnings and future earnings is weaker for firms with industrial diversification and stronger for firms with only global diversification. The results are robust with respect to alternative measures of diversification and controlling for size, book-to-market, institutional holdings, and earnings volatility. Collectively, this paper suggests that earnings informativeness is lesser for firms with industrial diversification, which weakens earnings persistence. In contrast, earnings informativeness is greater for firms with only global diversification, which enhances earnings persistence.