The Role of the Board in Unrelated Diversifications: Evidence from an Acquisition Wave in China

Unrelated diversifications are generally more viable in underdeveloped institutional environments because internal markets within the diversified firm can substitute the inefficient external ones. Using a sample of 498 major acquisitions undertaken during an acquisition wave by Chinese listed firms, we find acquiring a target firm in an entirely different industry can cause more severe goodwill impairment losses in the following two to four years, which indicates that acquirer managers tend to overestimate the synergistic gains they could realize in unrelated diversifications. Moreover, a capable board of directors can provide information advantages through outside directorship ties, structural hole position in the interlock network, and specialized committees, thus limit managers to make value-destroying diversification decisions. Further analysis suggests investors tend to prefer such unrelated acquisitions during the acquisition wave, indicating that shareholder expectations drive managers to diversify. By examining the role of boards as information conduits and advice-providers in limiting the cost of diversification in an underdeveloped institutional environment, this study contributes to the literature on diversification, acquisition and corporate governance.