The Effect of Functional Diversification on Financial Conglomerates: Evidence from European Countries

Sammanfattning: The purpose of this paper is to re-examine the diversification effect within banking industry and to check how it has been affected after the late-2000s financial crisis. The paper focuses exclusively on activity or function based diversification and evaluates how it affects market valuations of banks. The analysis is based on new dataset that includes only European banks covering the period from 2006 to 2010 and resulting in 750 observations. The results suggest that income diversification discount still persists as banks with diversified income sources have significantly lower market values. However, we do not find significant discount for banks that have diversified asset structure. Additionally, by performing various econometric tests and using control variables, we confirm that diversity per se causes the discount and not the underlying firm or country characteristics. Our findings correspond to the theories stressing that intensified agency problems in financial conglomerates outweigh economies of scope.