1. ¹Department of Finance, School of Business and Public Administration, Old Dominion University, Norfolk, USA
2. ²Senior Consultant, LECG, LLC, New York, USA

Correspondence: John A Doukas, Department of Finance, School of Business and Public Administration, Old Dominion University, Norfolk, VA 23529-0218, USA. Tel: +1 757 683 5521; Fax: 1 757 683 5639; E-mail: jdoukas@odu.edu

Received 2 June 2004; Revised 9 June 2005; Accepted 11 July 2005.

Abstract

Previous empirical studies have found that global diversification results in 18% shareholder loss. In this paper, we examine the sources behind the global diversification shareholder value loss in a contingent claims framework. This postulates that the risk-reduction effects of global diversification should decrease the value of shareholder equity (call option), whereas they should increase bondholder value. Consequently, near-all equity globally diversified firms should not experience a shareholder value loss. Consistent with the risk-reduction effects of global diversification, using cross-border acquisitions data we find three major results. First, shareholder value loss to global diversification is directly related to firms' leverage. Second, near-all equity firms do not trade at a discount. Third, the use of book value debt in estimating excess value produces a downward bias in globally diversified firms. Our findings confirm that increased foreign involvement increases bondholder value while it decreases shareholder value. This is consistent with the contingent claims view predicting that global diversification has a positive impact on bondholders' wealth while it has a negative influence on shareholder value (i.e., global diversification discount). Overall, our results reveal that global diversification does not destroy firm value.