Economies of Scope, Resource Relatedness, and the Dynamics of Corporate Diversification

Research summary: The dominant view has been that businesses that are more related to each other are more often combined within diversified firms. This study uses a dynamic model to demonstrate that, with inter-temporal economies of scope, diversified firms are more likely to combine moderately related businesses than the most-related businesses. That effect occurs because strong relatedness reduces redeployment costs and makes firms redeploy all resources to better performing businesses. The strength of that effect depends on inducements for redeployment measured as the current return advantage of one business over another business, volatilities of business returns, and correlation of those returns. This study develops hypotheses for those relationships and suggests empirical operationalizations, encouraging empiricists to retest the implications of relatedness for the dynamics of corporate diversification. Managerial summary: It is believed that diversified firms are more likely to combine more-related businesses because relatedness enables sharing of resources between businesses. Indeed, a firm can apply knowledge created in one business to another business, avoiding costly duplication in knowledge development. Resource sharing also adds value when a firm offers several products, adding the convenience of one-stop shopping and charging higher prices. However, resource sharing is not the only motivation for corporate diversification. In environments where profitability of businesses changes frequently, firms diversify by redeploying part of resources from an underperforming business to a better performing business. This study uses a dynamic model to demonstrate that, with that second motivation for corporate diversification, firms end up combining moderately related businesses rather than the most-related businesses

Rationalizing Organizational Change: A Need for Comparative Testing

Behavioral theory explains that organizational change is prompted by performance relative to a firm-specific aspiration. Although this explanation has been empirically confirmed, it has not been tested comparatively alongside other explanations, most notably rational choice. This lack of comparative study implies that prior research may be committing Type I errors—confirming aspiration-level decision making when it is not actually occurring. This paper contributes to behavioral theory in two specific ways. First, we show that several foundational studies purporting to provide empirical support for aspiration-level decision making may actually represent maximizing behavior. To consider this potential, we simulate a sample of subjectively rational agents who choose strategies by maximizing expectations. We show that it is possible and highly probable to diagnose satisficing when agents are, in fact, maximizing. Second, we develop and implement recommendations for comparative testing to demonstrate reliability. Analysis shows that the recommendations are effective at reducing Type I and II errors for both behavioral theory and rational choice. This paper is meant to inspire the design of future studies on aspirations and, indeed, all studies of organizational change

Economies of scope and optimal due diligence in corporate acquisitions

This study develops a theory of due diligence in corporate acquisitions. Using a formal model, the study situates due diligence in the context of prospective economies of scope, which are often sought by corporate acquirers but about which acquirers are incompletely informed. Relatedness, the key determinant of economies of scope, and ambiguity, the key determinant of incomplete information, are used to formally derive the optimal due diligence effort and the returns to acquirers that result from that effort. The derived theoretical predictions revisit the conventional wisdom that corporate acquirers cannot be too diligent or implicit assumption that such efforts are exogenous to the transaction. The predictions can be tested in future empirical research on corporate acquisitions, and they may also guide corporate acquirers on the optimal allocation of their research effort in acquisition deals

Redirecting research efforts on the diversification-performance linkage: The search for synergy

We review the literature on the diversification-performance (D-P) relationship to a) propose that the time is ripe for a renewed attack on understanding the relationship between diversification and firm performance, and b) outline a new approach to attacking the question. Our paper makes four main contributions. First, through a review of the literature we establish the inherent complexities in the D-P relationship and the methodological challenges confronted by the literature in reaching its current conclusion of a non-linear relationship between diversification and performance. Second, we argue that to better guide managers the literature needs to develop along a complementary path – whereas past research has often focused on answering the big question of does diversification affect firm performance, this second path would focus more on identifying the precise micro-mechanisms through which diversification adds or subtracts value. Third, we outline a new approach to the investigation of this topic, based on (a) identifying the precise underlying mechanisms through which diversification affects performance; (b) identifying performance outcomes that are “proximate” to the mechanism that the researcher is studying, and (c) identifying an appropriate research design that can enable a causal claim. Finally, we outline a set of directions for future research

Investigations into redeployability of corporate resources

A central theme in corporate strategy is that firm value is enhanced when managers have discretion to deploy a firm\u27s resources in more than one market. Two ways in which having such discretion creates value have been specified in the literature. First, firms can contemporaneously share resources across multiple markets, thereby gaining economies of scope, or synergy. Second, firms can exploit redeployability – managerial discretion to withdraw firm resources from one market and reallocate them to another market over time. While contemporaneous sharing has received wide attention in corporate strategy literature, understanding of implications of redeployability remains limited. The present thesis offers five complementary essays that illuminate the underexplored implications of redeployability. The five essays contribute to understanding of corporate strategy in a number of ways. The first essay qualitatively examines cases of two companies deploying their resources in multiple industries and marshaling those industries. It provides a better understanding of distinct managerial considerations involved in contemporaneous sharing and redeployability. The second essay complements qualitative insights from the first essay with a formal model disentangling contemporaneous sharing and redeployability and scrutinizing how such benefits separately and jointly contribute to firm value. The third essay further elaborates upon the value effect of redeployability by relaxing a prevalent, yet untested, assumption that the most related markets have both the lowest switching costs and the highest inducements for redeployment. The introduced formal model illustrates the extent to which the existing view of redeployability fails to recognize the value of redeploying resources to a less related market having higher inducements. The model in the third essay also quantifies the bias in predicting value of redeployability while ignoring its path dependent quality. The fourth essay considers an additional critical factor associated with redeployability and formally models mispricing of redeployable resources by outsiders. Such an analysis highlights a paradox associated with redeployability – even though redeployability provides valuable flexibility, firms may not be able to capitalize on such flexibility because they cannot attain the capital to exercise deployment options. Finally, the fifth essay formally reexamines the key topic of why some firms persistently combine multiple businesses in their scope. I explain such persistence in multiple businesses based on resource redeployability and, thus, complement the existing explanation based on contemporaneous sharing

Resource redeployment in corporate acquisitions : going beyond horizontal acquisitions

Resource redeployment between merging firms is an important way in which corporate acquisitions create value. Such redeployment can occur in horizontal deals when the acquirer and the target are from the same industry, or in non-horizontal deals when the acquirer and the target come from different industries. Although existing research focuses on the former scenario of resource deployment in horizontal acquisitions, resource deployment as a potential source of value in non-horizontal acquisitions has been understudied. This study uses a formal model to develop a theory of resource redeployment that both embraces and contrasts both types of acquisitions to offer new insights. The study concludes that the focus on horizontal acquisitions misses M&A contexts in which resource redeployment can create the highest value. Results from the model also demonstrate that acquisition performance has an inverse U-shaped relationship with relatedness between the merging firms. Finally, the effect of relatedness critically depends on the asymmetry in returns between the merging firms. These results are important for future empirical studies of acquisition performance and of target selection and are instructive to corporate managers seeking targets and managing potential redeployment of resources across organizations via M&A

Status exploitation: opportunity costs and dilution concerns in the Italian wine industry

It is well recognized that organizations attain “status” or prestige by affiliating with notable partners or institutions, and that there are clear benefits to high status positions. However, are there organizational limits to status exploitation? Whether status leads to firm expansion hinges upon if the benefits derived from status offset the costs. In this paper we estimate a model that distinguishes between benefits and costs associated with new product introductions. To address this issue we examine new product introductions in the Italian Wine industry between 2003-2009. Our results suggest that status may affect whether firms select to introduce new products