This paper provides empirical evidence of the relationship between diversification strategies in farm businesses and farm financial performance. We distinguish diversification into agricultural diversification and farm diversification into non-agricultural activities, depending on the source of farm business revenues.

We used panel data from 2016 to 2020 for Swedish farms and estimated two-way fixed effects models across the different farm types to control for farm-level unobserved heterogeneity and eliminate potential bias that can be caused by excluding unobserved variables that evolve over time.

The results indicate a heterogeneous relationship between agricultural and farm diversification and farm financial performance across farm types. In particular, agricultural and farm diversification are related to farm financial performance for dairy farms, and agricultural diversification is associated with farm financial performance for granivore farms. Regarding mixed, other grazing livestock and field-crop farms, we find no relationship between either type of diversification and financial performance.

The results are important because they highlight that farmers may not have the necessary financial incentives to adopt diversification strategies, although such strategies are considered desirable from a societal point of view, as they may contribute to positive environmental effects (agricultural diversification) and more prosperous rural areas (farm diversification). Consequently, from a policy perspective, our findings suggest that public support may be needed to strengthen farmers’ incentives to engage in diversification activities. For farmers and their advisors, our results may also contribute to more informed decision-making regarding diversification activities.