Diversification and Efficiency of Investment of East Asian Corporations

Abstract

We examine the efficiency of investment by diversified firms in nine East Asian countries, using a unique data of more than 10,000 firms over the 1991-96 period. We document the degree of diversification in the corporate sector, distinguish between vertical and complementary diversification, and study the differences across the nine East Asian countries. Based on the differential effect of vertical and complementary diversification on corporate performance, we test the misallocation-of-capital and learning-by-doing hypotheses. We find that the misallocation of capital is more pronounced in South Korea and possibly Malaysia than in Indonesia, Taiwan and Thailand, while the learning hypothesis is more pronounced for these three countries. Our East Asian sample provides diversity of development across countries, and enables us to further test these two hypotheses. We find evidence consistent with the learning-by-doing hypothesis that firms in more developed countries are successful in vertical diversification since they already make use of sophisticated technologies and may have peer firms to learn from. Furthermore, firms in more developed countries learn faster and improve their performance. We also find evidence consistent with the misallocation-of-capital hypothesis, as diversification by firms in less developed countries is subject to more misallocation of capital.