This article develops a dynamic model of a firm in which diversification can be a value-maximizing strategy even if specialization is generally efficient. The central idea is that firms are comprised of organizational capabilities that can be profitable in multiple businesses and that diversification is a search process by which firms seek businesses that are good matches for their capabilities. The theory can account for diversified firms trading at discounts compared to single-segment firms, as well as some empirical regularities that are challenging to the agency theory of diversification, such as positive returns to diversification announcements.
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