Diversification's effect and Manager Experience on Investment Efficiency

This paper discusses whether diversification is the optimal business strategy for a firm and whether diversification leads to efficient fund allocation. The analysis reveals that bad divisions in diversified firms exhibits over-investment with higher investment levels than ineffective specialized firms. Meanwhile, good divisions of diversified firms shows lower investment levels than effective specialized firms. This paper further analyzes three types of managers according to their time preferences, namely time-consistent exponential, less-experienced, and sophisticated managers. Their views on diversification and its effect on the investment efficiency are studied.