Diversification, Capital Structure, and Systematic Risk: An Empirical Investigation

Abstract

This study uses theoretical considerations to empirically examine the effects of various diversification strategies on the capital structure of firms and on the systematic risk. It documents that firms reduce their operating risk by diversification and increase financial leverage to take advantage of tax benefits. A cross-sectional path analysis is employed to show that firms trade off the reduction in operating risk due to diversification with increased financial leverage, and thus the systematic risk remains the same.