Corporate diversification and Ponzi finance

Abstract

This study aims to examine the conceptual link between corporate diversification and Ponzi finance, drawing on Minsky's financial instability hypothesis (FIH). While diversification is traditionally regarded as a strategy to mitigate risk, the analysis argues that diversification can paradoxically heighten financial fragility when firms expand beyond their core competencies. Specifically, diversification may reduce asset liquidity, increase reliance on debt financing and weaken profitability, thereby increasing the likelihood of firms engaging in Ponzi-type financial behaviors. The empirical analysis is based on China's A-share-listed non-financial firms over the period from 2006 to 2020. We employ a logit regression model to examine the relationship between corporate diversification and the likelihood of engaging in Ponzi finance, while controlling for a range of factors identified in prior literature as potential determinants of firms' financing regimes. To deepen the analysis, we conducted mechanism tests to identify the channels through which diversification influences Ponzi financing. We further perform heterogeneity and robustness checks and investigate potential strategies to mitigate the adverse effects of diversification. From a corporate governance perspective, the study shows that diversification increases financial risk, particularly exposure to Ponzi finance, by reducing transparency, weakening managerial oversight and encouraging inefficient capital allocation. However, firms with stronger institutional investor participation exhibit improved governance and are better positioned to reduce the adverse effects of diversification. Likewise, research and development (R&D) investment contributes positively to long-term financial sustainability. These results emphasize the critical role of governance mechanisms in managing diversification risks and provide practical implications for both firms and regulators seeking to align growth strategies with financial stability. This study suggests that policymakers and firms should strengthen corporate governance, enhance institutional investor oversight and promote R&D investment to mitigate the financial risks associated with excessive diversification and prevent the emergence of Ponzi finance, thereby fostering financial stability. Managers should avoid aggressive, debt-fueled diversification beyond their core competencies. Regulators should monitor diversified firms' financing structures more closely, strengthen disclosure requirements and encourage long-term, innovation-focused investments to curb hidden financial fragility and enhance systemic stability. Corporate over-diversification can increase systemic financial fragility, heightening risks of defaults and economic instability that affect employment, savings and public welfare. Promoting responsible corporate strategies and robust oversight is crucial for protecting societal interests and maintaining trust in the financial system. This study advances the literature by integrating Minsky's FIH with the relationship between corporate diversification and governance. It highlights how excessive diversification creates governance challenges that can amplify financial fragility while demonstrating the mitigating effects of institutional investor oversight and R&D investment. The findings offer new insights into how firms and policymakers can balance the pursuit of growth with the imperative of financial discipline and stability.