Empirical evidence on the determinants of the stock market reaction to product and market diversification announcements

Abstract

The announcement of product and market diversification projects lead to significant abnormal returns of 1.1%. However, the gains are higher for new products than for new markets, and for companies with high price-earnings ratios and low (or zero) dividend yields.

Acknowledgements

We are grateful to Ian Hirst, Mark Taylor (the editor) and an anonymous referee for valuable comments on previous versions of this paper. The responsibility for any remaining errors rests fully with the authors.

Notes

New product areas would include new products or product improvements which might be considered as ‘next generation’ and consequently compete in a different market situation to current products.

The joint venture category overlaps the other two subcategories.

The abnormal returns were also calculated using the market model, a trade-to-trade adjusted market model, and a trade-to-trade adjusted market adjusted returns model. Given the short event window, the impact of alternative models on the levels of abnormal returns is minimal, although the sample sizes are reduced for these alternative models, due to their additional data requirements. Abnormal returns are examined for the days t − 3 to t + 3 and it is found that the only significant abnormal performance is identified on day t, the day of the announcement, and that the abnormal return on day t is significantly different to each day before and after the announcement. Thus for our calculations we examine a one-day abnormal return for the day of the announcement.

The use of alternative market indices was examined but had a minimal impact since abnormal returns were calculated on a daily basis.

Jones et al. (2004) suggests project size relative to the size of the company may also be a major determinant of the level of abnormal returns, although Woolridge and Snow (1990) find project size to have little impact. This variable can only be calculated for 20 observations in the sample, due to missing information on project size. Additional untabulated tests revealed the coefficient for project size relative to company size to be positive, as predicted, although not statistically significant, due to the small sample when this variable was included.

See Gourlay and Seaton (2004) for a discussion of the characteristics of UK diversifying companies.

Regression models were selected for presentation after examination of a correlation matrix (not reported).

Regressions for the sub-sample of joint ventures are not presented as no variables were correlated with this category.