This research is aimed at examining the relationships between the corporate diversification strategy of a firm and the mode of financing this strategy. There are two aspects to the diversification strategy of a firm. The first deals with the type of business entered (related or unrelated), and the second considers the mode of diversification (internal development or acquisition). I argue that, because of market imperfections, the two aspects lead to two different risks for the lenders of funds. A related diversification project is the addition of relatively more firm-specific assets than an unrelated diversification project. This leads to a post-entry risk of governance for the lenders. Internal development into a new business is characterized by greater information asymmetry between the lenders and the firm, as compared to an acquisitive entry. This leads to a pre-entry risk of investment for the lenders. The characteristics of mode of financing are important to reduce the costs arising from these risks. Hence, debt financing versus equity financing, from public or private sources, are related to different types of diversification projects. Absence of a fit between strategy and mode of financing would lead to decreased performance. Furthermore, the moderating role of the board of directors composition is examined. It is suggested that monitoring from outside directors is likely to be more important in firms adopting a related diversification strategy, than in unrelated diversification. It is also argued that representatives of financial institutions on the board is likely to lead to more private financing.; Data were collected from a sample of firms adopting a diversification strategy. Analysis using Ordinary Least Squares and Tobit regressions provided reasonable support for the hypotheses. It appears that the corporate strategy of diversification does impact the firm's financing strategy. Evidence indicates that firm managers appear to be making choices with respect to financing type (debt versus equity) that are in line with the proposed model, but do not do so with respect to financing source (public versus private). Implications for issues connected with the cost of governance devices, and with performance measures are also presented.
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