Title: Overstatement of firm diversification effect on bankruptcy risk reduction

Authors: Zahra Faraji; Adam Fleischhacker

Addresses: Department of Financial Service Analytics, Alfred Lerner College of Business and Economics, University of Delaware, USA ' Department of Financial Service Analytics, Alfred Lerner College of Business and Economics, University of Delaware, USA

Abstract: This paper investigates the causal relationship between firm diversification and bankruptcy risk. Specifically, we examine the causal effect of diversification on the bankruptcy risk for US public firms using the Bayesian g-formula. We confirm the presence of a causal relationship between firm diversification and bankruptcy risk and discover results for US-based firms that are consistent with coinsurance theory; namely, diversification strategy reduces bankruptcy risk. However, the causal relationship is weaker than implied by most previous correlation literature, suggesting that the value of firm diversification has been overstated in related research and that causal techniques are useful in teasing out the true magnitude of an effect.

Keywords: firm diversification; bankruptcy risk; causal inference; Bayesian g-formula.

DOI: 10.1504/IJADS.2020.108496

International Journal of Applied Decision Sciences, 2020 Vol.13 No.3, pp.267 - 285

Received: 10 Apr 2019
Accepted: 03 Jul 2019
Published online: 14 Jul 2020 *

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