Bank Diversification and Market Valuation: An Analysis of Commercial Banks Listed in Nairobi Securities Exchange, Kenya

Abstract

The discourse on bank diversification and performance has long been based on accounting measures of performance. However, these measures only present the historical and present outlook of firm performance while ignoring the expected performance and risk assessments placed on such performance by the markets. Additionally, just like any other internal decision, managers can use time discretions over accounting data to minimize their personal and regulatory exposures. In an efficient financial market, it is expected that the market can account for managerial decisions in the market values of the firms. Such decisions include diversification. Agency theory has anticipated this scenario by proposing that diversification destroys value, though empirical evidence on the same is ambiguous. This raises the question of whether the financial market is efficient enough to value the diversification decisions of commercial banks and if so, what the effect of bank diversification on its market value would be. This research analyses the effect of income and asset diversification on the market value of commercial banks listed in the Nairobi Securities Exchange (NSE) over the period 2009 to 2017. The study controls for any possible valuation effects on a firm arising from its market power. Secondary data was obtained from Central Bank of Kenya Supervision Reports and the NSE Investor Handbook and analyzed using a Generalized Linear Model (GLM). The study finds a nonlinear relationship between income and asset diversification and market values which shows that the financial market in Kenya is efficient enough to place a value on the diversification decision of commercial banks. The study results also reveal that firms with more market power as a result of their size were valued more than small firms.