Chapter 6: Conclusions
6.2 Research limitations
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Figure 1: Research framework of this study Chapter 1: Introduction
1.1 Research background and motivation 1.2 Research purposes and research questions 1.3 Significance of the research
Chapter 2: Literature review 2.1 Literature review of diversification strategy 2.2 Literature review of human capital and experience
Chapter 3: Theory and hypotheses development 3.1 Context of study
3.2 diversification strategy 3.3 Experience
3.3.1 Experience of board
3.3.2 Experience of block shareholders
Chapter 4: Research methods 4.1 Conceptual framework
4.2 Research sample and data collection 4.3 Variables measurement
4.4 Data analysis methods
Chapter 5: Empirical results 5.1 Fundamental results
5.2 Regression analyses 5.3 Robust analyses
Chapter 6: Conclusions 6.1 Conclusions and implications
6.2 Research limitations 6.3 Future research
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Chapter 2: Literature review
2.1 Literature review of diversification strategy
Diversification strategy is one of strategies for corporate to develop competitive advantage. Most of firms implement diversification strategy for increase market share and enhance economies of scale. Diversification occurs when a firm spread its operation to other business, industry, market, and productions (Rumelt 1982).
Related literature define diversification as a firm entry into new lines of business activity through internal business development or acquisition (Ramanujam and Varadarajan 1989; Wan and Hoskisson 2003; Nath et al. 2010; Stern and Henderson 2004). Firms expect diversification strategy help them to enhance competitive advantage and then generate high performance. Therefore, the linkage between diversification and firm performance become important in strategic management field (Chen and Yu 2012; Ramanujam and Varadarajan 1989).
I summarize the theoretical perspective on diversification strategy as Table 1.
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Table 1: Literature summary of diversification strategy
Author (Year) Research Topic Research Method Research Conclusion and Research Implication Rumelt (1982) This study discusses the
relationship between diversification strategy and profitability.
1. Descriptive paper
2. The theoretical foundation is economies of scope of product diversification.
Research conclusion:
Diversification is the expansion of firms to produce and sell several types of products or a product line with no market interaction with each of the firm’s other products. According to the neoclassical theory of firm size, the diversification brings economies of scope to firms. Economics of scope increase the return of firms and decrease the transaction costs. The appropriate level of product diversity is balances economies of scope with diseconomies of organizational scale.
Research implication:
Product diversification is the basic form of diversification.
Diversification creates economies of scope for firms but should be in an appropriate level. Diversification not always brings benefit to firms. Therefore, I focus on the negative impact of the product diversification on firms’ performance.
Hill and
Hoskisson (1987)
This study discusses the strategies of multiproduct firms for realizing economic benefits.
1. Descriptive paper
2. The argument is based on a multiproduct firm.
Research conclusion:
Organizational and environmental constraints inhibit the benefit generation from diversification. Organizational constraints are the numbers of independent sub-units controlled directly by
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headquarter. The environment constraints are the impact of uncertainty. Under the uncertain environment, firms hard to manage interdivisional transaction. Therefore, firms have high requirements on information.
Research implication:
Firms in emerging market face high uncertain and imperfect environment. The benefit of diversification may not show in emerging market. Thus, in this study I investigate the negative impact of diversification on firm performance in an emerging market.
Ramanujam and Varadarajan (1989)
This study reviews the research related to
diversification and discuss the diversification research framework from the view of strategic management.
1. Literature review paper 2. Related paper from 1962-1963
Research conclusion:
This study concludes from prior related to literature and define diversification as the expansion of new lines of activity through internal business development or acquisition. The diversification changes firms’ administrative structure, systems, and other management processes. Therefore, one of the issues in corporate diversification is the relationship between diversity status, market structure, and performance.
Research implication:
This study provides a whole picture of diversification from the view of strategic management. Thus, I follow its definition of diversification and investigate the role of human capital in the
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relationship between diversification and firm performance.
Berger and Ofek (1995)
This study examines the effect of diversification on firm value for individual business segments.
1. Empirical study
2. Research samples are U.S.
companies.
3. Research period is from 1986 to 1991.
Research conclusion:
Overinvestment decreases the firm value for diversified firms.
Moreover, the business segments in diversified firms usually overinvest more than single-line business.
Research implication:
From the view of governance, the potential cost of diversification may be higher than potential benefit especially for those firms with multi-line business.
Geringer et al.
(2000)
This study discusses the association between diversification and firm performance.
1. Empirical study
2. The research samples are Japanese multinational companies.
3. The research period is from 1977 to 1993.
Research conclusion:
The relationship between diversification and firm performance changes over time. The impact of product diversity is weak on firm performance only in one time period.
Research implication:
This study discusses the impact of diversification on firm performance from the view of resource-based theory and transaction cost theory. These arguments are useful for us to understand the positive and negative impact of diversification on firm performance and then develop our hypotheses under emerging markets.
Khanna and Palepu (2000)
This study analyzes the difference in performance of
1. Empirical study
2. The research samples are Indian
Research conclusion:
The performance of group diversification decreases initially and
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un-affiliated firms in an emerging market.business groups.
3. The authors analyse data from 1993.
subsequently increases when group diversification exceeds a certain size. Moreover, the most diversified business groups are benefit from replicating the functions of institutions which are missing in emerging market.
Research implication:
Diversification has positive impact on firms through the increase of economies scope, but has negative impact on firms by high governance cost. Emerging market face imperfect environment includes contract enforcement, enforce property rights and regulatory structures. Firms in emerging market have to operate in highly divarication to face to uncertainty. From the view of governance, the cost of diversification is high. Firms may not perform well in the beginning of extend their business.
Rajan et al.
(2000)
This study develops a model of internal power struggles and resource allocation between divisions in
diversified firms and tests the prediction.
1. Empirical study
2. The research samples are diversified U.S. firms, include 156,598 firm-segment-years.
3. The research period is from 1980 to 1993.
Research conclusion:
Internal power struggles influence the research allocation between divisions. The resource misallocation damages the firm value. Moreover, the expectation of reallocation in the future distorts the investment of divisions today.
Research implication:
The political battles increase the cost of diversity of firms. From the governance view, the resource allocation to divisions would be inappropriate especially in an inefficient internal capital
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This study examines the relationship between diversified experience and firm excess value in U.S.
market.
1. Empirical study
2. The research samples are 7520 U.S. firms.
3. The research period is from 1984 to 1997.
Research conclusion:
The diversified experience decrease firms’ excess value.
However, the excess value of firms increase by cease being diversified experience. The findings of this study show that the costs of diversification may outweigh the benefit. The relationship between diversified experience and firm excess value is related to firms strategy choosing.
Research conclusion:
Diversification is not always brings benefit to every firm. Firms may suffer high cost in extend their scope when they have no resource or no ability. Thus, I examine the negative impact of diversification on firm performance.
Wan and
Hoskisson (2003)
This study examines the relationship between corporate diversification strategies, home country environments, and firm performance.
1. Empirical study
2. The research samples are 16 West European countries.
3. The munificent home countries are Denmark, France, Germany, The Netherlands, Norway, Sweden, Switzerland, and UK.
4. The less munificent home countries are Austria, Belgium,
Research conclusion:
In this study, home country is a factor that facilitates transformational activities and institutions that foster transactional activates. Home country environment has significant influence on firm’s diversification strategies. Product diversification has negative influence on firm performance under more munificent environments. However, product diversification has positive influence on firm performance under less munificent environments.
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Finland, Ireland, Italy, Portugal, Spain, and Turkey.
Research implication:
This study highlights the importance of product diversification for less munificent environments. Under the less munificent environments, firms create substitutes for factors and institutions through product diversification strategies. Thus, I discuss the role of product diversification in an emerging market.
Stern and Henderson (2004)
This study examines the relationship between within-business diversification and organizational survival.
1. Empirical study
2. The research samples are U.S.
personal computer manufacture firms.
3. The manufacturers are come from the industry’s founding in 1975 through 1994.
Research conclusion:
Within-business diversification is the extension of existing product lines or the extension of new product line. The relationship between within-business diversity and organizational survival depend on the amount of environmental change, such as the situation of firm’s competitors. When competitors diversify their own product portfolios and innovate technologically change the impact of within-business diversity on survival.
Research implication:
This study discusses within-business diversification from the view of resource sharing within business and product line structure based on resource-based theory and knowledge transfer. The discussion in this study is helpful in understanding diversification in technology-intensive industry by knowledge and technology change. Thus, I consider the industry knowledge
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from directors and block shareholders in the hypothesis related to impact of diversification on firm performance.
Brusco and Panunzi (2005)
This study develops a model to explain the diversification discount in conglomerates.
1. Analytical paper Research conclusion:
The process of headquarters reallocate funds across divisions is winner-picking. The ability of winner-picking may related to both costs and benefits. The results of this study show that ex ante diversity in divisions’ profitability increases the inefficiency of an internal capital market. Moreover, the mismatches between divisions’ size and profitability reduce the value of internal capital market.
Research implication:
The ability of decision makers in headquarter is a key to generate firm value from diversity operation.
Jiraporn et al.
(2006)
This study examines the relationship between firms’
diversification, corporate governance, shareholder rights, and firm value.
1. Empirical study
2. The research samples are U.S.
companies.
3. The research period is from 1993 to 1998.
Research conclusion:
When the shareholder rights are weak, firms manage diversification unwisely and decline their value. In this situation, firms suffer from a deeper diversification discount.
Research implication:
From the view point of governance, firms face high diversification discount by agency costs. The cost of diversification is more severe in weak governance than strong governance and then damage firm value.
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This study examines the relationship between CEO incentive compensation, allocation efficiency in an internal capital market, and diversification cost.
1. Empirical study
2. The research samples are U.S.
diversified firms.
3. The research period is from 1992 to 2003.
Research conclusion:
The benefit of diversification comes from the efficiency of allocation resources in an internal market. The self-interest of managers increase the misallocation in internal capital and then create diversification discount. However, this diversification discount may be ameliorated by CEO incentive compensation.
Research implication:
One of the reasons of diversification discount is the private benefits derived by managers. Therefore, the way to create value from diversification is eliminating managers’ self-interest behaviour such as increase incentive compensation or the monitor and advice from directors and shareholders.
Nath et al. (2010) This study examines the relationship between firms’
functional capability,
diversification strategies, and financial performance.
1. Empirical study
2. The research samples are UK based logistic companies.
3. The research period is from 2005 to 2006.
Research conclusion:
When firms implement their diversification strategies, they need the extensive knowledge of new product or services and they have to transfer of resources between parent and the partner companies. According to the resource-based view, the knowledge transfer between parent and partners is a complex process. Therefore, this study finds a negative impact of service diversification on business performance. The key of product or service diversification is the leveraging strategic resources and functional capabilities across different product or service.
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This study discusses the impact of diversification strategy from the view of resource-based view and finds a negative impact of diversification on firm performance. The arguments in this study are related to the process of knowledge and resource sharing in diversification strategy. Thus, I discusses the knowledge and resource from board and block shareholder.
Chen and Yu (2012)
This study examines the relationship between managerial ownership, corporate diversification, and firm performance from the view of agency theory self-interest perspective.
1. Empirical study
2. The research samples are 98 public traded in Taiwan Stock Exchange.
3. The research period is from 2006 to 2009.
Research conclusion:
The empirical results show that there is a U-shaped relationship between managerial ownership and corporate diversification.
Moreover, diversification has positive impact on short-term firm performance and no relationship with mid-term firm performance.
Research implication:
This study use Taiwanese data to discuss the impact of diversification on firm performance which is helpful for us to understand how corporate diversification affect firm performance in an emerging market. The arguments from agency theory also helpful for our hypotheses development on the linkage of shareholders and firm diversification.
Kistruck et al.
(2013)
This study examines the relationship between
1. Empirical study
2. The research samples are 3616
Research conclusion:
The key mechanism in the impact of charity’s diversification on
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3. The research period is from 1997 to 2001.
efficiency is the transaction costs. The transaction cost increase when charity seek out and maintain external resources from donors to develop their own capabilities. The empirical results show that the relationship between geographic diversification and efficiency is U shaped in nature. However, the relationship between product diversification and efficiency is inverted U shaped. This study suggests that the relationship between one type of diversification and efficiencies depends on the level of the other type of diversification.
Research implication:
This study addresses the problem of high transaction cost in the implementation of diversification. Thus, I consider the cost of obtaining external resource of firms in emerging markets.
Mayer et al.
(2015)
This study examines the role of prior diversification experience in firms’
diversification strategies.
1. Empirical study
2. The research samples are 187 European firms and 580 U.S.
firms.
3. The research period is 1993 to 2007.
Research conclusion:
Firms with high diversification experience have signification growth in product and international diversification. Any form of prior diversification experience helps firms to develop capabilities to expansion their product and international economics of scope.
Research implication:
This study investigates the role of prior diversification experience in the implement of product and international
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diversification. Prior experience is important in diversification strategies. Thus, I examine the industry experience from directors and block shareholders on the relationship between product diversification and firm performance.
Benito‐Osorio et al. (2015)
This study examines the relationship between product diversification and
performance.
1. Empirical study
2. The research samples are Spanish manufacturing firms.
3. The research period is from 1994 to 2008.
Research conclusion:
There is an inverted U-shaped relationship between product diversification and performance. This relationship is identical in different level of firm size. Product diversification-performance relationship change by the institutional environments. The optimal level of diversification is higher in larger firms.
Research implication:
This study discusses product diversification-performance relationship from the view of economics and finance and resource-based view. The discussion in this study provides a deep understanding of diversification.
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From Table 1, there are two main views in discussion of the relationship between diversification strategies and firm performance. One is from the view of resource-based theory and the other one is from the view of governance.
Based on resource-based view, firms have various natures of resources and depend on their ability to create new resources to achieve competitive advantage (Makadok 2001). Resource-based theory in diversification strategies discusses firms’
capabilities or tacit knowledge-based routines which can be extended from on factors of the firm to another. Product diversification strategies help firms leverage strategic resources and firm-specific capabilities across product lines. The leveraging of resources provide economies of scale to business-related capabilities and earn rents from more customers (Geringer et al. 2000). Diversification strategies generate sustained competitive advantage to firms and enhance their performance (Barney 2001). However, diversification strategy not only provides advantage but also generate some disadvantage to firms. Resource-based theory is also related to transaction cost economics theory (Conner 1991). Diversification increase the complexity of firm operation, no matter whether related or unrelated diversification.
The managerial and organizational complexities increase cost and conflict in firm operation (Geringer et al. 2000). Based on transaction cost theory, coordination cost increase due to increasing complexity from high diversification.
From governance view, firms overcome external capital market failures through diversification. Diversification strategy helps a firm to create its own internal market to solve agency problems. In diversified firms, head office is an internal shareholder which monitors the performance directly. The implication of diversification make firms allocate resources optimally and manage divisions more effectively than external capital market by generate cash flows internally and pool all resources
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together (Hill and Hoskisson 1987; Berger and Ofek 1995). However, diversification strategy may also increase governance cost (Geringer et al. 2000). The implementation of diversification increase information asymmetry and incentive misalignment between head office and division managers (Chen and Yu 2012). The power struggles between divisions in allocation resources. Firm value relate to resource misallocation and diversification discount (Berger and Ofek 1995; Rajan et al. 2000). Firma may input discretionary resources in value-decreasing investment or allocate funds to that poor division instead of better-performing divisions. These misallocation increase diversification discount and decrease the value of diversify firms.
There are both benefit and cost from resource-based view and governance view.
Diversification literature still cannot find consistent evidence in the relationship between diversity and firm performance. Therefore, I will list the arguments and findings in related research from these two view point.
2.1.1 Resource-based view
The researches of diversification strategies are based heavily on the resource-based theory. However, Conner (1991) argues that resource-based theory is related to transaction cost theory. The governance cost increase from high level of diversification. Although diversification strategies reduce bureaucratic costs from internal market governance, the increased size and complexity of firm may usually cause the accumulated inefficiencies. Geringer et al. (2000) combine resource-based theory and transaction cost theory to argue that the relationship between diversification strategy and firm performance is non-linear. Diversifications bring
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strategic resources and capabilities to firms and create greater scope. On the other hand, diversification also increases a lot of cost such as product exceeds the range of rent-yielding resources and governance scope surpasses management capabilities.
This study uses the Japanese multinational firms as sample to show that diversification has influence on firm performance but this influence change over time.
However, product diversification strategies hardly vary over time, despite great change in Japan. This result shows that as environmental conditions is a factor in the relationship between diversification and firm performance. When external
However, product diversification strategies hardly vary over time, despite great change in Japan. This result shows that as environmental conditions is a factor in the relationship between diversification and firm performance. When external