Impact of diversification strategy on capital structure, systematic risk and corporate performance in Indian context

Abstract

This study investigates the impact of diversification strategy on capital structure and corporate performance of corporate sector in India. It also computes the relationship between corporate capital structure and corporate performance with systematic risk. The researcher explores important and statistically significant effects through the study such as effect of diversification strategy on corporate performance and corporate value creation using cross sectional data. The data for the present study is taken from well known academic data house known as Prowess of CMIE (Centre for Monitoring Indian Economy). The sample for study is a set of all the companies which diversified during the year 2006-2011 and are listed at BSE (Bombay Stock Exchange) as well as NSE (National stock exchange) of India. In line of identification of the study variables, the dependent variables of the study are capital structure (Leverage), systematic risk and corporate performance through structured models know as the Leverage (LEV) Model, Market Risk (β) Model and Corporate Performance Model. The dependent variables of the study such as corporate capital structure is measured by popular corporate leverage ratio like, debt equity ratio or total debt to total assets (TDTA) some of the other ratios are total debt to total assets (TDTA), long-term debt to total assets (LTDTA) and short-term debt to total assets (STDTA) are used as proxies for capital structure. Further the systematic risk of the companies is measured by calculating the covariance of market movement with respect to that of the stock movement [Cov (Ri,Rm)/Var (Rm)]. The corporate financial performance is price earnings (PE) Ratio measured profit after tax / total assets, and return on equity and (ROE) measured by profit after tax / no. of shares outstanding. However, the independent variables are classified as Diversification Index (DI), Corporate Size (SIZ), Profitability (PROF) and Asset Tangibility (AT). The extent of diversification can be measured using various index found in the literature like Herfindahl Index (HI), Entropy Index (EI) etc. calculated using corporate revenues. Based on the results of regression analysis (OLS) using E-views 7 software, it has been found that diversification strategy have a significant and negative impact on all corporate capital structure, also supported by Kakani (2000). Corporate size, has a positive and significant impact on leverage, which is consistent with a past study of Antonkik (2006), Banker (2011), Barton (1988) and clearly indicates that corporate size is an important determinant of corporate capital structure. Corporate capital structure has positive and significant impact on corporate value creation, through elaborated product diversification strategy which is measured by popular financial measurement indicator. It can be concluded, from the study that the trend towards increasing degrees of corporate diversification could prove to be quite valuable to the strategists who are attempting to improve the corporate performance through effective management of the diversity, experienced in a multi business corporate. Moreover, future studies could employ different measures of product and geographical diversification, according to the degree of relatedness of product