A global study on the relationship between firms' diversification into the financial services industry and their financial performance

Over the last two decades, fundamental changes have occurred in the financial services industry which industry observers term "revolutionary". Authoritative observers consider deregulation, developments in information and communications technology (ICT) and changes in the economic environment to be three of the most important driving forces behind the changes which have occurred in the industry. These developments have also resulted in a number of less traditional players such as non-financial companies and financial conglomerates becoming increasingly involved in the financial services industry. In this Thesis, non-financial companies are defined as companies which are involved in the provision of financial services but which derive the major part of their income from other business activities. Ford Motor Company and Marks & Spencer are typical examples. Although the literature on diversification indicates that several benefits such as synergy, economies of scope, the reduction of transactions costs through the creation of internal capital and other markets, an increased borrowing capacity and a reduction of the tax burden may arise through this strategy, the empirical studies fail to reach consensus on the matter. The studies are not conclusive as to whether diversification into related areas of activity has resulted in benefits to firms though there is some agreement that 'unrelated' or 'conglomerate' diversification has produced few benefits. It thus appears paradoxical that a substantial number of non-financial companies have diversified into the financial services industry and the objective of this Thesis is to determine whether these firms derived any real financial benefit by diversifying into the industry. To investigate this issue, two samples of quoted non-financial companies were drawn from the Worldscope database. A sample of 716 non-financial companies was matched with a similar number of control companies on the basis of their SIC code, market capitalisation, market-to­book ratio and geographic location. A sample of 148 non-financial companies was matched with a similar number of pseudo control companies on the basis of their SIC code, financial and non­financial segmental sales value and geographic location. The financial performance of the non­financial and control groups of companies between 1989 and 1998 was then compared, share return being used as the main gauge of financial performance. The results of the analyses carried out indicate that the non-financial companies generally reaped financial benefits by diversifying into financial services whilst they did not generally suffer financial disadvantages by implementing this strategy. However, the study also reveals that differences in the non-financial companies' financial performance emerge when these are analysed according to the different types of financial services products they offer, the geographic areas in which they operate and the primary industry in which they operate. Differences also emerge when the non-financial companies' financial performance is analysed according to the degree of their diversification into financial services activities. The evidence suggests that the non-financial companies' advantageous financing structures contributed to the achievement of their financial results and it is hypothesised that these companies were in a position to develop such structures as a result of their diversification into financial services activities, this being due to their enhanced ability to develop internal capital markets and to liase with external suppliers of funds which increased their opportunities to obtain finance whilst reducing the related transactions costs. Evidence of synergy between the non-financial companies' financial services and non-financial activities emerges in this context. Since the non-financial companies are engaged in a moderate amount of diversification into financial services activities, and the literature equates a moderate amount of diversification with related diversification, support is also provided to the theoretical arguments that firms would be expected to benefit by diversifying into related areas of activity