Management Decision

Purpose – The purpose of this paper is to investigate whether, and to what extent, corporate diversification into related and unrelated businesses affects capital structure choices, and whether ownership structure is germane to the understanding of corporate diversification strategies and debt-equity financing choices.

Design/methodology/approach – Univariate approaches include the parametric two-sample t-test, non-parametric Kolmogorov-Smirnov test and Kruskal-Wallis rank test, and cluster analysis. Multivariate approaches include panel data regressions to identify the sign and magnitude of the effect of diversification on capital structure, after controlling for a number of industry and firm characteristics as suggested in the literature.

Findings – Corporate diversification into related or unrelated industries has opposite effects on capital structure, after controlling for ownership structure and corporate governance mechanisms. Consistent with the prediction of organizational economics, an increase in the degree of business relatedness is associated with a reduction in debt while an increase in business unrelatedness is associated with an increase in debt. In addition, there is strong evidence that government-controlled firms use less debt financing and that government ownership weakens the positive relationship between unrelated diversification and leverage. The results are robust to different measures of capital structure.

Originality/value – Traditional finance literature has not been able to provide conclusive evidence on what affects corporate capital structure decisions. This paper shows that a corporate strategy perspective, with its emphasis on a managerial decision-making process, can provide a behavioral basis for understanding capital structure choices.