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Corporate Diversification
... Understanding the nature and determinants of diversification has long been seen as one of the most fundamental issues in strategy research (Chandler, 1969; Guillen, 2000; Montgomery, 1994; Peng and Delios, 2006; Peng et al., 2009; Porter, 1987; Rumelt, 1974; Rumelt et al., 1994). ...
... In order to understand why diversification levels may exceed " efficient " levels (Montgomery 1994: 175) research has thereby typically looked to mechanisms of corporate governance in general and patterns of ownership in particular (Aggarwal and Samwick, 2003; Thompson and Wright, 1995; Fiss and Zajac, 2004; Amihud and Lev, 1981; Fox and Hamilton, 1994; Montgomery and Singh, 1984). For these key determinants of corporate strategic behaviour agency theory usually provides the foundational theoretical framework (Hitt et al., 2006: 856; Thomsen and Pedersen, 2000; Shleifer and Vishny, 1997). ...
... Recent studies have begun to explore the impact of specific types of owners on strategic decisions (Miller et al., 2010) including diversification (Gomez-Mejia et al., 2010). These studies address a key critique of earlier agency theory based arguments: in contrast to the assumption of substantive homogeneity, different types of owners (families, financial institutions and the state) will differ in the expectations they set for firm strategy, leading to different types of strategic choices and outcomes (Ramaswamy et al., 2002; David et al., 2010; Kang and Sørensen, 1999; of firm scope, with agency theory providing the foundational theoretical framework (Denis et al., 1997; Montgomery, 1994). Agency theory assumes that managers, as agents, pursue their own personal goals rather than the interests of their principals, the company's owners (Fama and Jensen, 1983; Jensen and Meckling, 1976). ...
This paper examines the impact of ownership on product and international diversification. While ownership concentration has received considerable attention from agency theorists we argue that a more nuanced analysis is necessary. We consider how the identity of owners moderates the impact of ownership concentration on diversification strategies. We develop a framework that explains how the combination of different motivations, resources and capabilities associated with different types of owners results in significantly variable relationships between ownership concentration and both product and international diversification. From a theoretical perspective this suggests a social contextualization and extension of the agency theoretic approach that characterizes the field. Based on a study of 222 European firms between 1994 and 2007 we show that family ownership concentration has a positive impact on product and a negative impact on international diversification while the impact of institutional and state ownership concentration is negative on product diversification and positive on international diversification compared with family ownership. This is the first study to provide a comprehensive framework explaining how ownership concentration and identity interact and affect both international and product diversification.
... At the same time, the vast majority of empirical studies comparing the performance of unrelated multibusiness firms to either single-business firms or related diversifiers, found that the multibusiness firm underperformed (e.g. Rumelt 1982; Singh and Montgomery 1987; Montgomery and Wernerfelt 1988; Lubatkin and Chatterjee 1994; Markides and Williamson 1994; Montgomery 1994; Anand and Singh 1997 1 ). This empirical evidence would lead us to expect conglomerates to disappear over time due to market pressures. ...
... Overall, a number of arguments for the superiority of related multibusiness firms exist, and these are complemented by broad empirical support for the claim that unrelated diversifiers underperform their related diversified or single-business peers (e.g. Montgomery 1994; Rumelt 1982; Montgomery and Wernerfelt 1988; Anand and Singh 1997; Singh and Montgomery 1987, again, also acknowledge and cite the others view). This is consistent with the fact that the number of multibusiness companies that follow a strategy of unrelated diversification has decreased substantially since the 1970s (Goold and Luchs 1993). ...
... Another key area in which private equity firms can help their portfolio companies become more profitable is through coaching and counseling in setting the strategic direction, in defining performance targets and in developing detailed business plans (Anders 1992; Baker and Montgomery 1994; Baker and Wruck 1989). The enhancement of strategic distinctiveness and the development of ambitious "stretch budgets" are important ingredients of successful buyouts (e.g. ...
... Understanding the nature and determinants of diversification has long been seen as one of the most fundamental issues in strategy research (Chandler, 1969; Guillen, 2000; Montgomery, 1994; Peng and Delios, 2006; Peng et al., 2009; Porter, 1987; Rumelt, 1974; Rumelt et al., 1994). ...
... In order to understand why diversification levels may exceed " efficient " levels (Montgomery 1994: 175) research has thereby typically looked to mechanisms of corporate governance in general and patterns of ownership in particular (Aggarwal and Samwick, 2003; Thompson and Wright, 1995; Fiss and Zajac, 2004; Amihud and Lev, 1981; Fox and Hamilton, 1994; Montgomery and Singh, 1984). For these key determinants of corporate strategic behaviour agency theory usually provides the foundational theoretical framework (Hitt et al., 2006: 856; Thomsen and Pedersen, 2000; Shleifer and Vishny, 1997). ...
... Recent studies have begun to explore the impact of specific types of owners on strategic decisions (Miller et al., 2010) including diversification (Gomez-Mejia et al., 2010). These studies address a key critique of earlier agency theory based arguments: in contrast to the assumption of substantive homogeneity, different types of owners (families, financial institutions and the state) will differ in the expectations they set for firm strategy, leading to different types of strategic choices and outcomes (Ramaswamy et al., 2002; David et al., 2010; Kang and Sørensen, 1999; of firm scope, with agency theory providing the foundational theoretical framework (Denis et al., 1997; Montgomery, 1994). Agency theory assumes that managers, as agents, pursue their own personal goals rather than the interests of their principals, the company's owners (Fama and Jensen, 1983; Jensen and Meckling, 1976). ...
This paper examines the impact of ownership on product and international diversification. While ownership concentration has received considerable attention from agency theorists we argue that a more nuanced analysis is necessary. We consider how the identity of owners moderates the impact of ownership concentration on diversification strategies. We develop a framework that explains how the combination of different motivations, resources and capabilities associated with different types of owners results in significantly variable relationships between ownership concentration and both product and international diversification. From a theoretical perspective this suggests a social contextualization and extension of the agency theoretic approach that characterizes the field. Based on a study of 222 European firms between 1994 and 2007 we show that family ownership concentration has a positive impact on product and a negative impact on international diversification while the impact of institutional and state ownership concentration is negative on product diversification and positive on international diversification compared with family ownership. This is the first study to provide a comprehensive framework explaining how ownership concentration and identity interact and affect both international and product diversification.
... This occurs as a consequence of the greater possibility for innovation and diversification of activities associated with firms that have highly intensive R&D. Montgomery (1994) and Sutton (1998) argue that R&D intensity acts as a barrier to entry due to considerable sunk costs that new competitors face. Therefore, and given the lower rate of entry in sectors with high R&D intensity , the growth of established firms with high R&D intensity becomes easier. ...
... Therefore, and given the lower rate of entry in sectors with high R&D intensity , the growth of established firms with high R&D intensity becomes easier. Aside from SMEs' recognized ability to diversify activities, which is fully debated in the literature on SME performance (Audretsch 1991; Agarwal 1997; Giarratana 2004; Auerswald 2008), other studies of reference suggest the positive effects of R&D intensity on businesses' growth patterns, namely in terms of: (i) more efficient diversification of SME activities (Montgomery 1994; Deloof 2003; Rogers 2004); (ii) SMEs' increased export capacity, diminishing the business risk associated with their activities (Beise-Zee and Rammer 2006); (iii) greater capacity for SMEs to establish strategic cooperation networks with other firms (Rogers 2004; Rickne 2006; Garrigos et al. 2010; Koppinen et al. 2010); (iv) greater tendency for SMEs to operate in market niches (Jones 1987); and (v) greater organizational flexibility that can allow SMEs to face successfully possible unanticipated changes in market conditions, meaning therefore greater sustainability of firm growth (Rogers 2004). Nevertheless, R&D intensity can cause a reduction in SME growth, since: (i) R&D intensity can represent a high risk, which together with the high risk inherent in activities carried out by SMEs, can lead to problems of financing R&D activities when internal financing is insufficient, contributing to decreased growth in SMEs that implement R&D business activities (Yasuda 2005; Müller and Zimmermann 2009; Elmquist and Le Masson 2009; Olausson and Berggren 2010); (ii) for firms to make efficient use of R&D investment, they sometimes need a long learning period, and so in the short-term R&D business activity can imply diminished SME growth (Müller and Zimmermann 2009; Bessant et al. 2010); (iii) R&D investment usually involves considerable amounts of money and therefore requires access to substantial financing resources (internal or external), which in the case of SMEs can be problematic in terms of firms' short-term financial management (Tanabe and Watanabe 2005; Gomez and Vargas 2009; Müller and Zimmermann 2009; Bianchi et al. 2010); and (iv) compared to large firms, SMEs have greater difficulty in managing scarce resources that can be allocated to innovative activities, such as highly qualified human resources, information and technology (Freel 2003; Tanabe and Watanabe 2005). ...
Based on a sample of Portuguese SMEs for the period 1999–2006 and using two step estimation, namely probit regressions and dynamic estimators, this study makes two important contributions to the literature: (i) identification of a quadratic relationship between R&D intensity and SME growth that takes the form of a U, and so R&D intensity is a stimulating factor of SME growth for high levels of R&D intensity; being a restrictive factor of SME growth for low levels of R&D intensity; and (ii) the growth of SMEs seems to be dependent on the nonlinear effects associated with distinct levels of R&D intensity. The nonlinear effects identified suggest that Portuguese SMEs with high levels of R&D intensity more easily find an efficiency scale and are more dependent on internal financing and short-term debt as sources for funding growth, compared to the case of Portuguese SMEs with lower levels of R&D intensity.
... Diversifying firms are most likely to add value if they capitalize on unique resources that cannot be otherwise transferred across firm boundaries through contractual arrangements (Coase, 1937; Penrose, 1959; Williamson, 1985; Montgomery, 1994). Because successful diversification hinges on scarce resources, it is a priori difficult to say if connections improve or worsen the performance consequences of diversification. ...
... Why firms diversify is extensively researched by economists and management scientists. It has been argued that firms diversify to capitalize on non-contractible unique resources (Penrose, 1959) such as managerial talent (Chandler, 1977; Montgomery, 1994) or organizational capability (Matsusaka, 2001), to bypass external markets subject to distortion (Williamson, 1985; Stein, 1997), to exercise monopoly power (Hill, 1985; Villanonga, 2000), or to reduce risk (Lewellin, 1971; Khanna and Yafeh, 2005). ...
We examine the diversification patterns of almost all publicly listed non-financial companies in China during the 2001 to 2005 period. More than 70 percent of the firms in our sample are diversified. We document that patterns of diversification strongly depend on firms' political connections. Former local bureaucrats are more likely than other CEOs to enter multiple industries. This effect is particularly pronounced in state-owned enterprises (SOEs) that operate in weak institutional environments. These companies are particularly prone to entering low-growth, low-profitability, and unrelated industries. Consequently, the performance effects of diversification differ sharply across SOEs and private firms. While the latter earn a premium from diversifying their operations, SOEs do not. Our results are consistent with the view that provincial and local governments push Chinese SOEs into unattractive sectors of the economy and that politically connected CEOs use their relationships to build corporate empires.
... Literature that directly links cooperatives to product diversification is not available. However, clues might be found in existing perspectives that explain the choice of product diversification (Hoskisson and Hitt, 1990; Montgomery, 1994; Ramanujam and Varadarajan, 1989). These perspectives are rooted in different theories or paradigms, notably agency theory (Jensen, 1986), transaction cost economics (Williamson, 1975), the resource-based view of the firm (Penrose, 1959), industrial organization (Palepu, 1985) and strategic contingency theory (Venkatraman, 1989). ...
... Managers may prefer to diversify, even into activities that reduce the value of the firm, because of personal mo tives , like reduction of employment risk (Montgomery, 1994). Since the shareholders of a corporation have other means to reduce their risks, they are assumed to oppose this kind of diversification. ...
Product diversification and its financial outcomes have been studied exhaustively. However, previous literature has focused on corporations, ignoring other important legal organizations or governance structures. In this paper, we study the diversification strategies of cooperatives and compare them with corporations. We develop hypotheses that predict that cooperatives differ from corporations with respect to the extent, type, and performance of product diversification. Data obtained from a sample of 118 cooperatives and corporations are used to test the hypotheses. We find significant differences between cooperatives and corporations. Therefore, our main conclusion is that governance structure does matter for product diversification and its performance. Other governance structures, besides corporations and cooperatives, and their influence in other areas, besides product diversification, could be promising directions for future research.
... The process of firm diversification has been widely investigated in the literature both from a theoretical and from an empirical perspective. Berry (1975) defines diversification as the increase in the number of sectors in which a specific firm is active. Pitts and Hopkins (1982) put forward a notion of diversification which is less related to the sector and more associated with firms' specific activities. ...
... As concentration promotes an investment of specialized assets (e.g. Hill and Jones, 1992; Montgomery, 1994), it is important to thereby outline the nature of such specialized assets. In the context of food safety research, specialized food safety assets include investments in a firm's food safety reputation and those assets that support a firm's reputation (e.g. ...
Food safety is an inherently complex agribusiness problem. Food safety is a result of the collec-tive efforts of various members of the food supply chain in which each member's production, handling, processing and retailing practices jointly determine the safety of the consumed product. Although agency explanations have been offered as one potential solution to this research chal-lenge, food safety also operates within a greater institutional setting. A theoretical framework that draws on an institutional approach is developed in which two sets of propositions are offered to explain the coordination and economic organization of food safety. Such a framework offers four contributions / implications to organizational economic and food safety research. © 2012 International Food and Agribusiness Management Association (IFAMA).
... Corporate contingency research is rooted firmly in the market failures paradigm (Ramanujam and Varadarajan 1989; Hoskisson and Hitt 1990; Montgomery 1994). The real options literature has tended to focus on discrete investment projects such as research and development, extra production capacity, or product launches (Trigeorgis 1995; Amram and Kulatilaka 1999). ...
Diversified corporations competing in industries characterized by uncertain and rapidly changing structures can enhance their competitiveness by increasing their level of strategic flexibility, i.e., their ability to reconfigure divisional relationships to exploit shifting industry-level complementarities. The value of this kind of strategic flexibility can be understood using a real options framework. Specifically, part of the value of a diversified portfolio of operating assets is a function of the present value of future synergies between currently unrelated businesses that are subject to market convergence. By diversifying and acquiring assets in industries subject to increasing complementarity, firms acquire the right, but not the obligation, to pursue interdivisional synergies when and as appropriate. In other words, under particular circumstances, diversification creates real options on the integration of currently separate operating units. This paper investigates the administrative implications of attempting to create and exercise real options on future synergies through diversification. For whereas an investor can acquire and exercise a financial option simply by issuing the appropriate “buy”
... Specialization allows farmers to pursue the production of those commodities for which they have the greatest relative advantage or the least relative disadvantage given the physical and biological factors and economic forces that limit their enterprise possibilities (Castle, Becker, and Nelson, 1987). Nonetheless, as Montgomery (1994) points out, the diversified (multi-product) firm still is the rule rather than the exception. ...
Enterprise diversification is a self-insuring strategy used by farmers to protect against risk. This study examines the impact of various farm, operator, and household characteristics on the level of onfarm enterprise diversification. Evidence exists that larger farms are more specialized. Also, farmers who participate in off-farm work, farms located near urban areas, or farms with higher debt-to-asset ratios are less likely to be diversified. In contrast, evidence suggests there is a significant positive relationship between diversification and whether the farm business has crop insurance, is organized as a sole proprietorship, or receives any direct payments from current farm commodity programs.
... In the fourth phase, the stagnant phase, two challenges for established firms are of interest for our discussion. First, since growth opportunities are dried up, established firms will look to other product markets to use their capabilities and diversify accordingly (Dosi/Teece/Winter 1992, Montgomery 1994). Second, there is a threat that incumbents are threatened by innovative new entrants who are successfully entering the market. ...
... Diversification through coinsurance of cash flows provides other benefits as well. First, the firm's expected tax liabilities may be reduced in an asymmetric tax-code regime (see Bhide, 1990; Graham and Smith, 1999). Second, the reduction in cash-flow uncertainty may lower the expected bankruptcy costs (see Smith and Stulz, 1985; Mayers and Smith, 1990; Bessembinder, 1991). ...
This paper investigates the "more-money" effect of corporate diversification for-mulated in Stein (2003). We find that diversified firms have significantly lower loan rates than focused firms, and find no evidence that diversified firms are subject to more restrictive non-price contract terms such as maturity, collateral requirements, and covenant restrictions. Diversified firms utilize their lower costs of bank debt by raising more external financing, but they access the external capital markets less frequently than focused firms. We show that there is a limit to this favorable effect of corporate diversification: as the extent of corporate diversification grows, the cost of bank debt eventually increases after reaching a minimum. Our results suggest that corporate diversification can affect the capacity for external financing and that there is an optimal scope of diversification in achieving the "more-money" effect.
... Corporations may decide to diversify for profit motive (Chatterjee & Wernerfelt, 1991; Hall & Lee, 1999; Amit, Livnat & Zarowin, 1989; Montgomery, 1994). However, financial economists in 1990s started to query the effect of diversifications as value increasing strategies, and they continue to provide empirical studies that diversification is generally a value decreasing strategy. ...
This study provides evidence on ownership structures and corporate diversification by analysing 355 public listed companies (PLCs) in Malaysia. The majority of the companies in the sample have an ultimate controlling owner, particularly an individual or family. As controlling owners have on average, rights of control over a greater percentage of shares in any given company than their rights to participate in the cash flows from that company, controlling owners may have an incentive to expropriate minority interests through methods such as inefficient corporate diversification. The risk of such expropriation would be expected to be reflected in the value of highly diversified companies. The results of the research provide no evidence to support the argument that diversification reduces the value of companies. However, the finding is consistent with the argument that high control rights of controlling owner might encourage expropriation of minority interests through corporate diversification strategies. Thus, corporate diversification in Malaysia is perceived as a mixed blessing strategy.
... Firm diversification is widely analyzed in the strategy and financial economics literature. The literature distinguishes between related and unrelated diversification and finds positive performance effects mainly for the former category (Montgomery, 1994; Palich et al., 2000). Rumelt (1974, p. 29) describes two businesses as " related to one another when a common skill, resource, market, or purpose applies to each " . ...
Two pathways from user innovations to commercial products have been described in the literature: the transfer of user innovations to a manufacturer, and the innovator’s switch of functional role from user to manufacturer. This paper explores a pathway hitherto not studied, namely, the vertical diversification of a user firm and subsequent coexistence of user and manufacturer units as a “user-manufacturer innovator”. Such coexistence potentially enables the manufacturer unit to benefit from a continuous stream of user innovations, while the user unit profits from a steady flow of improved tools. On the other hand, selling user innovations on the market risks giving away the competitive advantage originating from use of the innovations. Based on a detailed case study of Bauer AG, a firm active in both the specialist foundation engineering business and the machinery industry, we derive a set of 10 propositions regarding the conditions under which such an integration of user innovator and manufacturer is attractive and viable in the long run. These conditions relate to innovation, market, and corporate governance and organization, respectively. Subsequently, we validate the propositions with three additional cases from the tunnel construction, tea packaging, and geological surveying industry. Our study makes three contributions to the literature on user innovation. First, we provide an example of user entrepreneurship originating from a corporation rather than from an individual user. Second, we show that an integration of user innovator and manufacturer in one firm can be viable in a steady state, and describe the pertaining conditions. Third, we link user innovation to corporate strategy, exemplifying how user innovation may contribute to redefining the boundaries of the firm. We conclude by pointing out implications for practice and avenues for future research.
... We focus on bank loan contracting because bank loans are primary sources of corporate financing. Bradley and Roberts (2004) show that since 1994 the private bank debt of corporations has been much larger than the public debt. 1 There has also been an increased level of corporate diversification in recent decades through mergers and acquisitions (see Montgomery, 1994; Pryor, 2001; Harford, 2005). The concurrent increases in the levels of bank financing and in corporate diversification in recent years make it important to understand how the diversification of a firm's business operations affects the pricing and structure of its loans. ...
This paper investigates the effect of a firm's organizational structure on its debt financing activities. Using corporate diversification strategy as an identification tool for organizational structure, we find that diversified firms have significantly lower loan rates than comparable focused firms, and we find no evidence that diversified firms are subject to more restrictive non-price contract terms pertaining to maturity, collateral requirements, and covenant restrictions. We show that the effect of diversification on the cost of a bank loan is channeled primarily through coinsurance in investment opportunities and cash flows and that the effect is nonlinear: as the extent of corporate diversification grows, the cost-reduction benefit of diversification decreases. Our results indicate that the organizational structure of the firm can alleviate its external financing constraints and that it has an important bearing on the firm's financing capacity.
... The RBV suggests that a firm's resource stock impacts a firm's profitability and its breadth of product diversification (Agarwal & Ramaswami, 1992). Extending this argument, resource stock would also influence the level of geographic diversification since the antecedents to product and international diversification (e.g., intangible assets which have some properties of a public good) are similar (Montgomery, 1994). We further argue that since they possess a stronger stock of resources, larger firms may be in a better position to successfully compete with host country firms especially in developed countries (Agarwal & Ramaswami, 1992) and absorb the high costs and risks in international operations (Hoang, 1998; Hood & Young, 1979). ...
In this study, we examine the location strategies (e.g., developing versus developed countries) of Chinese multinational firms (Pantzalis, 2001). We argue that domestic firm-specific ownership advantages of a firm, in the form of larger size and higher degree of diversification, will induce internationalization into developed countries rather than into developing countries. We also predict that internationalization into developed countries will help performance but internationalization into developing countries will hurt performance. Based on an analysis of data on 154 Chinese listed MNCs from 1992 to 2002, we found support for our predictions.
The phenomenon of outsourcing is becoming increasingly widespread among organizations and is now one of the strategic decisions that attract the greatest interest from professionals and organizational scholars. The primary purpose of the paper is to contribute with a review of the principal works that address outsourcing from the resource-based view of the firm (RBV). The paper begins by setting out the main premises of outsourcing and then presents the different concepts of outsourcing and proposes a concept that is more in line with the theoretical framework used. This is followed by an analysis of the principal differences and similarities of the treatments of outsourcing from the traditional perspective of the transaction costs economics theory (TCE) and from the more strategic and up-to-date RBV. The next section contains a review of the most significant theoretical and empirical works on outsourcing that address outsourcing from the RBV. The contributions are classified into two categories, depending on the objectives: works that study the propensity to outsource and works that study the relationship between the outsourcing decision and organizational performance. Finally, a framework is proposed that is based on the resource and capability view with the aim of contributing to a better understanding of outsourcing and facilitating future empirical works from the RBV that are complementary and examine issues of greater interest that have been less developed in the literature to date.
After more than 20 years of empirical research, the resource-based view of the multibusiness firm has emerged as a promising paradigm for explaining diversification success—one of the most investigated research questions within the field of strategic management. However, because various dimensions of resource-relatedness, synergistic effects, and moderating influences are investigated at diverse levels of analysis, the findings are very fragmented. Our review and critical assessment of the research reveals a number of conceptual issues and methodological flaws that had already constrained heavily traditional diversification research. Consequently, we suggest promising directions for future research efforts that can put this important empirical application of the resource-based view of the firm on safer ground.
This paper seeks to investigate whether age is a fundamental characteristic of the relationships between determinants and growth. The empirical evidence obtained allows us to conclude that: (1) age and size are restrictive factors of the growth of young SMEs, but they are not important for the growth of old SMEs; (2) cash flow and debt are of greater relative importance for growth in young SMEs than for growth in old SMEs; (3) R&D intensity and labour productivity are of greater relative importance for growth in old SMEs than for growth in young SMEs; (4) interest on debt is of greater relative importance for diminished growth in young SMEs than for diminished growth in old SMEs; and (5) R&D intensity in situations of financial deficit is of greater relative importance for diminished growth in young SMEs than for diminished growth in old SMEs, but only in context of high-tech SMEs.
We focus on the relationship between age and diversification patterns of German machine tool manufacturers in the post-war era. We distinguish between ‘minor diversification’ (adding a new product variation within a familiar submarket) and ‘major diversification’ (expanding the product portfolio into new submarkets). Our analysis reveals four main insights. First, we observe that firms have lower diversification rates as they grow older, and that eventually diversification rates even turn negative for old firms on average (where negative diversification corresponds to exit from certain product lines). Second, we find that product portfolios of larger firms tend to be more diversified. Third, with respect to consecutive diversification activities, quantile autoregression plots show that firms experiencing diversification in one period are unlikely to repeat this behavior in the following year. Fourth, survival estimations reveal that diversification activities reduce the risk of exit in general and to a varying degree at different ages. These results are interpreted using Penrosean growth theory.
The existing literature on the relationship between strategy and structure tends to ignore the legal dimension of the organization of diversified firms. Yet, there is considerable variation in the legal organization of diversified firms; while some of these firms are organized as simple corporations, many are organized as "corporate groups" in which certain lines of business are organized as separate, subsidiary firms. In this paper we argue that this variation in legal organization is observed because le- gal organization can significantly affect firm value. In particu- lar, forming subsidiary firms to accommodate new businesses can protect the outstanding stakeholders of a diversified firm from increases in bankruptcy risk and liability exposure. How- ever, forming subsidiary firms also reduces economies of scope. Hence, there are offsetting costs and benefits to adopting dif- ferent types of legal organization. Changes in these relative costs and benefits over time can also be expected to trigger changes in legal organization, as well as the divestiture of busi- nesses characterized by particular types of economic hazards. (Diversification ; Organization Structure; Subsidiary Firms)
This article examines the adoption of information communication technology (ICT) and its diffusion and network effects. The ICT diffusion is illustrated by vertical and horizontal spillover effects of ICT usage in the high-technology industries. The analysis focuses on the impact of ICT adoption on vertical and horizontal integration and how does it change the cost of internal coordination, external coordination, and production. Previous literatures suggested that the use of ICT is found to be associated with substantial decreases in vertical integration and weak increases in diversification. This study examines the empirical relationship between ICT and firm structure and evaluates whether this structure is consistent with prior arguments about ICT and coordination when explicitly considering ICT network effects. We overview and identify the dynamic perspectives of the ICT network effects. The ICT impacts, its network effects, and its associated adjustments on industry and enterprise are examined and estimated for Taiwan high-technology industries.
Managers’ integrity refers to a manager’s behavior that is consistent with his/her espoused value and that he/she is honest and trustworthy (Barry & Stephens 1998; Yukl & Van Fleet 1992). As a social notion, integrity also refers to the degree to which people (e.g., managers) satisfy the legitimate expectations of the world around them (Kaptein 1999); this is, their stakeholders. Corporate governance refers to “those administrative monitoring and incentive mechanisms that are intended to reduce conflicts among organizational actors due to differences in incentives” (Lubatkin et al. 2007, p. 43). In other words, governance concerns the structure of rights and responsibilities among the firm’s stakeholders (Aguilera & Jackson 2003; Usunier, Furrer & Furrer-Perrinjaquet 2011). In this chapter, we focus those corporate governance issues that pertain to managers’ integrity. This is, corporate governance requires controlling the risk of opportunism by managers as well as ensuring their integrity.
This paper investigates conflicts of interest associated with relationship banking. Using a sample of 306 German initial public offerings (IPOs), we ask if universal-bank-underwritten IPOs perform differently from other IPOs. We find that universal-bank affiliation is correlated with higher first-day returns (underpricing), but uncorrelated with long-term performance. This suggests that underpricing compensates for potential conflicts of interest. We also find that pre-existing bank relationships, rather than issuer characteristics, appear to determine the choice of underwriter.
G rowing interest in knowledge as a competitive asset suggests the benefit of studying professional service firms (PSFs). These firms are highly successful examples of organizations whose ability to manage knowledge is critical to their success. Furthermore, they are worthy of study because they constitute a significant sector of the economy, whether measured by their size, numbers, or influence. Despite their significance, little is known of the determinants of their performance. This paper proposes that the core tasks of PSFs raise unusual strategic and organizational challenges, the resolution of which affects organizational performance. We elaborate the effects of reputation and diversification and contrast them to theory for goods-producing industries. We also hypothesize that PSF managers face a choice in designing structures between the retention and motivation of the professional workforce and transferring knowledge from partners to other professionals. These predictions are tested and supported by data from the largest 100 U.S. accounting firms for the period 1991–2000. The paper thus contributes to a theory of professional service firm management.
U.S. petrochemical firms invested heavily in capital expenditures during a period of low growth opportunities following the 1973 oil price shock. These investments were associated with lower stock returns and decreases in operating income. This paper examines whether the investment problem can be attributed to the firms' governance structures, as the agency theory predicts. It finds that the firms' capital investments are negatively associated with the proportion of their board seats held by outside directors, controlling for leverage, firm size, and investment opportunity. This finding is consistent with the argument that outside directors take part in monitoring capital expenditure decisions in declining growth industries. In addition, firms which tie CEO cash compensation to shareholder wealth are less likely to invest in capital spending. On the other hand, this paper does not find that capital investments are related to insider equity holdings, a result inconsistent with the agency view arguing for the incentive alignment effect of managerial equity ownership. In an event study of investment policy changes, it is documented that announcements of expansive (contracting) investment policies on average decrease (increase) shareholder wealth. However, these wealth effects are not related to the firms' governance characteristics. The paper also examines the interactions of the firms' governance structures, their diversification policies, and their performance, but fails to find a significant relation. The lack of relation suggests that diversification policy in the petrochemical industry is distinct from capital investment policy and is less explainable by the agency theory. On balance, the evidence in this paper provide partial support for the agency view and suggest future research toward alternative explanations on problems associated with corporate downsizing.
Dynamic capabilities (DC) are concerned with the ability of organizations to change. Literature on DC does not always consider the degree of change in the organization and the degree of proactivity implied by the interaction between the organization and the environment. We suggest that the latter feature is specifically relevant in the case of SMEs where innovation and growth is often associated with the exploitation of new business opportunities. Empirical evidence shows that new venture creation by established entrepreneurs is often carried out through the setting up of new companies, thus resulting in the formation of a business group. One of the main reasons for this is to involve other persons in the ownership and control of the new business. This is in accordance with theoretical m odels of entrepreneurial specialization that underline the difficulty for entrepreneurs to create new ventures while retaining the ownership and control of the ones already established. This difficulty can be overcome by enlarging the entrepreneurial team. The paper suggests that the manipulation of the governance structure of groups through the development of an entrepreneurial team is an important capability in SMEs to sustain their processes of innovation and growth.
This paper describes the International Finance course at Harvard Business School for instructors considering adopting the associated material. The paper begins by arguing that the forces of globalization have fundamentally changed the scope and activities of firms thereby altering the practice of finance within these firms. As a consequence of an increasing reliance on tightly-integrated foreign operations, a parallel world of finance has been opened within every multinational firm and this world has, heretofore, been overlooked. The course materials are designed to address the many aspects of financial decision making within global firms prompted by these changes that are not addressed in traditional materials. The paper provides an overview of the structure of the course and its seven modules with particular emphasis on the three modules that constitute the core of the course. The paper also describes an analytical framework that has been developed through the creation of the course materials to guide critical financial decisions on financing, investment, risk management and incentive management within a multinational firm. This framework emphasizes the need to reconcile conflicting forces in order for multinational firms to gain competitive advantage from their internal capital markets. The paper concludes with a discussion of the course's pedagogical approach and detailed descriptions of all the course materials, including 19 case studies, corresponding teaching notes, several module notes and supplementary materials.
Manuscript Type: Empirical
Research Question/Issue: This study investigates the association between the composition of the board of directors and corporate diversification, to explore the role of the board in corporate strategic choice.
Research Findings/Results: Based on a sample of 101 Australian publicly listed firms in 2005, this study finds that there is no link between corporate decisions on product and/or geographic diversification and two aspects of board composition – board independence and institutional representation. However, there is a positive link between total diversification and a third aspect of board composition – the proportion of directors who have ties to boards of corporations in other industries.
Theoretical Implications: The results provide support for the managerial hegemony and the resource dependency theories. Corporate strategic decisions regarding diversification are more likely to be made by management than boards of directors, and to be encouraged by interlocking directors with extra-industry ties.
Practical Implications: Contrary to the requirement or recommendation in many jurisdictions that boards be more independent, these results indicate that shareholders' interests, represented by lower levels of diversification, are not promoted under such circumstances. Interlocking directors appear to effectively link the corporation to the external business environment and to encourage diversification. Existing recommendations and regulations to align management with shareholders' interests through independent boards should be revised. Board composition should also consider directors' knowledge, relevant expertise, availability, and length of tenure.
There is no clear theoretical consensus about the overall effect of firm diversification on the magnitude of asymmetric information problems that firms face. We therefore compare stock market based measures of asymmetric information for diversified firms with those they could reasonably expect to exhibit if they were split along industry lines into separately traded entities. We find that approximately 74% of the diversified firms in our sample have less severe asymmetric information problems as conglomerates than they could expect to experience as separately traded pure-play firms. We also find evidence that diversified firms with low levels of information asymmetry trade at significant diversification premiums while diversified firms with high levels of information asymmetry trade at significant diversification discounts.
The process of mergers and acquisitions has gained substantial importance in today's corporate world. This process is extensively used for restructuring the business organizations. In India, the concept of mergers and acquisitions was initiated by the government bodies. Some well known financial organizations also took the necessary initiatives to restructure the corporate sector of India by adopting the mergers and acquisitions policies. The Indian economic reform since 1991 has opened up a whole lot of challenges both in the domestic and international spheres. The increased competition in the global market has prompted the Indian companies to go for mergers and acquisitions as an important strategic choice. The trends of mergers and acquisitions in India have changed over the years. The immediate effects of the mergers and acquisitions have also been diverse across the various sectors of the Indian economy. Till recent past, the incidence of Indian entrepreneurs acquiring foreign enterprises was not so common. The situation has undergone a sea change in the last couple of years. Acquisition of foreign companies by the Indian businesses has been the latest trend in the Indian corporate sector. The Indian IT and ITES sectors have already proved their potential in the global market. The other Indian sectors are also following the same trend. The increased participation of the Indian companies in the global corporate sector has further facilitated the merger and acquisition activities in India. The various factors that played their parts in facilitating the mergers and acquisitions in India are favorable government policies, buoyancy in economy, additional liquidity in the corporate sector, and dynamic attitudes of the Indian entrepreneurs are the key factors behind the changing trends of mergers and acquisitions in India. Even though mergers and acquisitions (M&A) have been an important element of corporate strategy all over the globe for several decades, research on M&As has not been able to provide conclusive evidence on whether they enhance efficiency or destroy wealth. There is thus an ongoing global debate on the effects of M&As on firms. This article seeks to explore the trends and progress in M&As India.
This paper reviews the vast academic literature on the market for corporate control. Our main focus is the cyclical wave pattern that this market exhibits. We address the following questions: Why do we observe recurring surges and downfalls in M&A activity? Why do managers herd in their takeover decisions? Is takeover activity fuelled by capital market developments? Does a transfer of control generate shareholder gains and do such gains differ across takeover waves? What caused the formation of conglomerate firms in the wave of the 1960s and their de-conglomeration in the 1980s and 1990s? And, why do we observe time- and country-clustering of hostile takeover activity? We find that the patterns of takeover activity and their profitability vary significantly across takeover waves. Despite such diversity, all waves still have some common factors: they are preceded by technological or industrial shocks, and occur in a positive economic and political environment, amidst rapid credit expansion and stock market booms. Takeovers towards the end of each wave are usually driven by non-rational, frequently self-interested managerial decision-making.
We exploit a natural experiment to examine how an exogenous reduction in firm scope influences product-level performance over time. Using detailed micro-data on every Peruvian fishing firm before and after a regulatory shock that banned mackerel fishing, we find that reducing the scope of the firm led to sharply lower productivity in firms’ legacy anchovy fishing business. The results suggest that diversification creates positive interdependencies between products that are eliminated when the firm refocuses its operations. However, we find that the productivity effect attenuates over time, suggesting that while firms are rigid in the short-run, in the long-run they efficiently adapt in response to changes in scope.
This paper presents new evidence on the impact of industrial diversification and partner business relatedness on the shareholder wealth effects of international joint ventures (IJVs). By employing a comprehensive database containing worldwide joint venture announcements, we examine the shareholder value of 1042 international joint venture (IJV) announcements made by US firms from 1999-2008. In general, there is significant evidence that shareholders of US partners announcing IJV investments in foreign countries realize positive abnormal returns. Further analysis demonstrates that IJVs invested outside of the core businesses of both US and foreign partners and formed by partners with different core businesses are most value-increasing for US shareholders. In contrast to the previous literature that indicates corporate diversification is linked to the destruction of shareholder value, our results show that diversification through IJV investments increases shareholder value of US partners, and partner business unrelatedness can further enhance value creation from diversification. The diversification premium found in this paper also provides some supporting evidence that the international joint venture may be a preferred mode over international acquisitions and Greenfield FDI when US firms engage in foreign direct investments (FDI) outside of their core businesses.
The link between diversification and performance has become an important topic for research in diverse fields such as strategic management, industrial organization and financial management. However, a synthesis of the research done in developed and emerging markets is missing. This paper attempts such a synthesis by comparing and contrasting the past cumulative empirical research evidence on the relationship between diversification and firm performance in the context of developed economies to the more recent work in the emerging economies. The empirical literature has been divided into three broad perspectives, and the paper highlights the considerable diversity in its findings in developed and emerging markets across each of these perspectives. Based on this study, it is proposed that related diversification is preferable in developed economies and should be based on specific resources, whereas unrelated diversification is appropriate in emerging economies and should be based on generic resources. Although agency problems exist in both contexts, it is argued that the type of problem differs in developed and emerging markets. The paper concludes by identifying three directions for future research. First, the relationship between diversification and performance should be examined across each industry separately and not in aggregate. Secondly, future research needs to examine the organizational mechanisms required to make diversification successful. Finally, the relationship needs to be examined under unstable and dynamic situations such as the current global economic downturn.
Over the last 20 years, the resource-based view (RBV) has reached a pre-eminent position among theories in the field of strategy, but debate continues as to its precise nature. This paper contributes to the debate by critically reviewing the development of the RBV to date. The critical appraisal examines the development of the RBV in terms of theory, method, empirical evidence and practical insights. It is contended that the permeable and eclectic nature of the RBV stems from its being a theory about what firms are and how they function, and that its popularity is due to an absence of limiting behavioural assumptions. Finally, the authors provide their own subjective views on where they think RBV scholars should focus their efforts in the future.
This article examines causes of product-line diversification in the largest 200 U.S. corporations between 1986 and 1996. The analysis shows that some corporations decreased their level of diversification. However, in contrast with previous studies, other corporations became more diversified. Change in the number of first-level subsidiaries and the value of mergers and acquisitions influenced corporate diversification. In contrast with the multidivisional form, the organizational characteristics of the multilayer-subsidiary form give management greater capacity to socialize capital, pursue mergers and acquisitions, and manage a large and diversified corporation. This multilayer-subsidiary form limits the managerial problem of bounded rationality by organizing product lines and product groups in legally independent subsidiary corporations that are embedded in their respective markets.
The external environment is characterized by periods of relative stability interspersed with periods of extreme change, implying that high performing firms must practice exploration and exploitation in order to survive and thrive. In this paper, we posit that R&D expenditure volatility indicates the presence of proactive R&D management, and is evidence of a firm moving from exploitation to exploration over time. This is consistent with a punctuated equilibrium model of R&D investment where shocks are induced by reactions to external turbulence. Using an unbalanced panel of almost 11,000 firm-years from 1997 to 2006, we show that greater fluctuations in the firm's R&D expenditure over time are associated with higher firm growth. Developing a contextual view of the relationship between R&D expenditure volatility and firm growth, we find that this relationship is weaker among firms with higher levels of corporate diversification and negative among smaller firms and those in slow clockspeed industries.
Integrating the impact of both resource and institutional factors and taking into consideration potential agency problems, this study proposes to investigate the joint effect of both related and unrelated diversification strategies on firm performance in an emerging economy setting and to assess empirically the hypothesized relationship using Chinese firms. The empirical results support the basic contention that both resource building and utilization through concentration and related diversification and institutional environmental management through unrelated diversification are important for firm performance in emerging economies but they must be considered together. This paper concludes with a discussion of its contributions, practical implications, and directions for future research.
This study is among the first to systematically evaluate the role of foreign ownership (volume of ownership and board representation) on self-interested strategizing behavior of organizational managers. Building on agency theory, strategic management and organization theory literatures, it argues that the volume of foreign ownership is unlikely to have any bearing on the extent of unrelated diversification that managers pursue. However, the level of foreign representation on the board of directors is likely to dampen such strategies. Results from the empirical examination set in India provide support for this line of reasoning. Contributions, implications and future extensions are explored.
This paper argues that the political resources owned by Chinese private enterprises affect their diversification strategy
under the context of China’s transitional economy. Based on the sample of top 500 private enterprises in 2004 in China, we
find the following empirical evidence: First, political resources owned by private enterprises are positively and significantly
related to their degree of diversification. Second, the possibility for private enterprises to diversify their business by
entering industries under government regulation is positively related to their political resources. Third, the possibility
of related diversification for private enterprise is negatively related to its political resources.
在中国经济转轨背景下, 民营企业拥有的政治资源通过影响民营企业的多元化策略而影响民营企业的成长。 以全国工商联颁布的民营企业 500 强 (2004) 为样本, 在控制其他影响因素的情况下, 发现了支持以上论断的经验证据: 第一, 民营企业拥有的政治资源与民营企业的多元化程度之间存在显著正相关关系;
第二, 民营企业进入政府规制行业进行多元化的可能性与民营企业拥有的政治资源正相关; 第三, 民营企业进行相关多元化的可能性与民营企业拥有的政治资源负相关。
This paper examines the effects of information technology (IT) adoption on the productivity of multimarket small and medium-sized
enterprises (SMEs). The main hypothesis is that IT usage increases efficiency to a higher degree in diversified and internationalized
firms compared with single-market SMEs. This hypothesis is tested using a large sample of more than 2,000 Spanish SMEs. Overall,
intensive use of IT in operations processes is found to be associated with substantial increases in productivity of firms
following both related and unrelated diversification. Also, exporting firms with more intensive use of IT have higher productivity.
These results are consistent with previous theoretical arguments on the relationship between IT and efficiency of firms and
open future research directions related to the role played by IT in the management control systems of both diversified and
exporting firms.
KeywordsProductivity paradox–Performance–Diversification–Internationalization–Small and medium-sized enterprises–Information technology
This article examines the effect on market valuation of both corporate governance and the diversity of activities conducted
by GCC commercial banks. It shows evidence on the endogenous effect of corporate governance and the characteristics of the
banking industry in determining the diversification level of a bank. Empirical findings show a bias in results using ordinary
least squares regressions. When controlled for endogeneity, they indicate a negative (but weak) association between the diversification
index and the market valuation—consistent with the agency-based hypothesis. Interestingly, foreign banks and corporate shareholders
are effective monitors who invest in more diversified GCC banks with higher valuation multiples. Conversely, domestic corporate
shareholders—related by a complex web of relationships—invest in less diversified banks with a lower market valuation. In
addition, diversified commercial banks with either subsidiaries in developed countries or involvement in market-based activities
have higher market valuation. The latter may be explained by the effect on performance of the recent bubble in the Arab stock
market.
The strategic importance of learning and knowledge development in alliances has been widely recognized and discussed in literature,
though focusing mainly from the view of the demand side and leaving the equally important ingredient of knowledge owners’
incentives-to-teach intact. This paper blends the perspectives of the transaction-costs economics (TCE) and the knowledge-based
view (KBV) in a hypothesized governance model that illustrates how knowledge and location factors of international partners
jointly impact alliance strategies. We first identify the relevant knowledge and location factors affecting incentives-to-teach
in alliances, and then incorporated them into a framework explaining the choice of contractual or equity-based mode governing
an alliance. Eight hypotheses are developed and then tested on a sample of 640 international alliances, with at least a partner
from a focal emerging economy, Taiwan. Our research findings show that the contractual mode is usually aligned with higher
incentives-to-teach of the knowledge owners, especially in knowledge-asymmetric and location-symmetric alliances. In a contrast,
the equity-based mode, offering additional safeguarding mechanisms for the knowledge owner, is often selected in the alliances
associated with a severe concern of competition, especially in knowledge-symmetric and location-asymmetric alliances.
KeywordsKnowledge-asymmetry-Location-asymmetry-International alliance-Governance-mode-Emerging economies
This study examines the impact of resource configuration, specifically diversification and resource concentration, on the
performance of business groups in an emerging economy. Diversification indicates the product/market portfolio of a business
group, while resource concentration illustrates the degree of resource dispersion among different affiliates within a business
group. Based on the data collected from 125 Taiwanese business groups from 2004 to 2007, this study finds that resource concentration
positively influences the performance of business groups, while diversification has a negative impact on the performance of
business groups. The findings of this study provide support to the resource-based view and the market power perspective of
business groups. This study also finds that the appropriate organizational form may change over time, confirming the institution-based
view of business groups in emerging economies.
KeywordsDiversification-Resource concentration-Performance-Business groups
The types of investments a firm undertakes will depend in part on what it expects the outcome of those investments to reveal about its skills, capabilities, and assets (i.e., its resources). We predict that a firm will specialize when young, then experiment in a new line of business for some time, and then either expand into a large, multisegment business or focus and scale up its specialized business. We derive several empirical implications for firm valuations and the reaction of stock prices to news about firm prospects. We also offer a novel explanation for the well-documented “diversification” discount.
Managers frequently cite the desire to mitigate asymmetric information as a motivation for increasing firm focus. The information benefits of focus appear relevant for the subset of firms that actually increase their focus; however, the relevance of focus-related information benefits for the population of diversified firms is an open question. This paper examines the relation between corporate diversification and asymmetric information proxies derived from analysts’ forecasts and abnormal returns associated with earnings announcements. I find that greater diversification is not associated with increased asymmetric information. These results call into question the notion that corporate diversification strictly exacerbates information problems.
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