Corporate diversification and the value of individual firms: A Bayesian approach
| Author | Jay B. Barney,Jeffrey P. Dotson,Tyson B. Mackey |
| Published date | 01 February 2017 |
| Date | 01 February 2017 |
| DOI | http://doi.org/10.1002/smj.2480 |
Strategic Management Journal
Strat. Mgmt. J.,38: 322–341 (2017)
Published online EarlyView 9 February 2016 in WileyOnline Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2480
Received 9 January 2012;Final revisionreceived 20 October 2015
CORPORATE DIVERSIFICATION AND THE VALUE
OF INDIVIDUAL FIRMS: A BAYESIAN APPROACH
TYSON B. MACKEY,1*JAY B. BARNEY,1and JEFFREY P. DOTSON2
1Department of Entrepreneurship and Strategy, University of Utah, Salt Lake City,
Utah, U.S.A.
2Marketing, Brigham Young University, Provo, Utah, U.S.A.
Research summary: Prior theory suggests that the performance effects of a rm’s diver-
sication strategy depend on a rm’s individual resources and capabilities and the set-
ting within which it is operating. However, prior tests of this theory have examined the
average diversication-performance relationship across all rms, instead of estimating the
diversication-performance relationship at the individual rm level. Efforts to estimate this
average relationship are inconsistent with a central assumption of much of strategic manage-
ment theory— that rms maximize value by choosing strategies that exploit their heterogeneous
resources and individual situation. By adopting an approach that allows an evaluation of the
diversication-performance relationship for individual rms, this article shows that rms, both
focused and diversied, tend to choose that diversication strategy—focus, related diversica-
tion, or unrelated diversication—that maximizes value.
Managerial summary: Instead of a universal diversication discount or premium, this article
shows that the effect of diversication on performance is heterogeneouslydistributed across rms
and that rms tend to be rational in their diversication decisions. Copyright © 2015 John Wiley
& Sons, Ltd.
INTRODUCTION
It may be the case that more has been written about
the relationship between corporate diversication
and rm performance than any other topic in the
eld of strategic management. Theoretically, some
scholars have focused on the performance effects
of different types of diversication (e.g., related
versus unrelated) (Teece, 1980, 1982), while oth-
ers have focused on when rms can enhance their
performance by engaging in diversication instead
of remaining focused (Gomes and Livdan, 2004;
Maksimovic and Phillips, 2002; Montgomery and
Wernerfelt, 1988). Taken as a whole, prior theory
suggests that the ability of a diversication strategy
Keywords: Bayesian methodology; endogeneity;
corporate diversication; diversication discount;
resource-based theory
*Correspondence to: Tyson B. Mackey, 1655 E. Campus Center
Drive, SFEBB 1113, room 8153, Salt Lake City, UT 84112.
E-mail: tymackey@gmail.com
Copyright © 2015 John Wiley & Sons, Ltd.
to create value depends on the specic resources
and capabilities controlled by a rm. For example,
are they leveragable across multiple different busi-
nesses and the contexts within which they are oper-
ating (Teece, 1980)? Similarly, are there growth
options in a business (Kogut, 1991).
Of course, this theoretical literature has given
rise to a large empirical literature. Some of this
work has examined the average impact of different
types of diversication (e.g., related and unre-
lated) on rm value (Bettis, 1981; Chatterjee and
Wernerfelt, 1991; Markides and Williamson, 1994;
Palepu, 1985; Palich, Cardinal, and Miller, 2000;
Rumelt, 1982), while other work has examined the
average impact of diversication on a rm’s value
relative to a portfolio of focused rms (Berger and
Ofek, 1995; Lang and Stulz, 1994; Montgomery
and Wernerfelt, 1988). Overall, this empirical work
seems to suggest that, on average, related diver-
siers outperform unrelated diversiers (Rumelt,
1982) and that, controlling for the propensity to
Corporate Diversication and the Value of Individual Firms 323
diversify, diversied rms do not, on average,
trade at a discount (or perhaps at a small premium)
compared to focused rms (Campa and Kedia,
2002; Miller, 2004, 2006; Villalonga, 2004).
However, despite this voluminous empirical
research, there is a fundamental mismatch between
the theoretical diversication literature— which
examines the relationship between diversication
and rm performance for individual rms— and
the empirical diversication literature— which
examines the average relationship between diversi-
cation and rm performance for a sample of rms.
Such a mismatch would not be problematic if it
was possible to infer the rm-specic relationship
between diversication and performance from the
average relationship between diversication and
rm performance in a sample of rms. However,
this will rarely be the case. In particular, know-
ing that— on average— rms pursuing related
diversication strategies outperform rms pursu-
ing unrelated diversication strategies does not
necessarily imply anything about the relationship
between the type of diversication strategy chosen
and performance for a particular rm. The value
maximizing strategy for a particular rm depends
on that rm’s resources and capabilities and the
context within which it is operating, not on the
relationship between diversication strategy and
rm value for a “hypothetical” average rm.
The purpose of this article is to re-examine
the relationship between a rm’s diversi-
cation strategy and its performance using a
method— hierarchical Bayesian modeling —that
enables the estimation of this relationship at the rm
level. Consistent with prior theory, the empirical
results in this article show that all forms of diversi-
cation strategy— related diversication, unrelated
diversication, and remaining focused— can cre-
ate value for different rms. Indeed, most rms
in the sample studied in this article choose a
value-creating diversication strategy.
THEORY AND HYPOTHESIS
DEVELOPMENT
This section briey summarizes previous theoret-
ical work on the relationship between a rm’s
diversication strategy and its performance and
derives a single hypothesis from this previous
work. Empirical work that examines the average
relationship between diversication strategy and
rm performance is also briey reviewed, together
with a discussion of why it is rarely possible to infer
the relationship between diversication and perfor-
mance for a single rm from the average relation-
ship between diversication and performance for a
sample of rms.
Firm diversication and performance: theory
Received theory in strategic management describes
conditions under which a rm can enhance its
economic value by engaging in related diversi-
cation, unrelated diversication, or by remaining
undiversied. It also describes conditions under
which a rm may abandon its prot-maximizing
objectives in choosing its diversication strategy.
Each of these arguments is briey summarized
below.
Related diversication and rm value
Perhaps the largest of these theoretical literatures
focuses on the settings within which a rm can
enhance its value through related diversication
(e.g., Bettis, 1981; Chatterjee and Wernerfelt,
1991). A rm is said to be engaging in related
diversication when it exploits resources and
capabilities across multiple different businesses
simultaneously (Rumelt, 1982). These kinds of
shared resources can create an economy of scope
within a diversied rm such that the value of
multiple businesses combined can be greater than
the value of these businesses separately. Prior
theory suggests that when diversication exploits
an economy of scope that outside equity holders
cannot duplicate on their own or that could not be
replicated through market or intermediate forms of
governance, diversication can create value for a
rm’s shareholders (Teece, 1980, 1982).
A wide variety of potential economies of scope
have been identied in the literature including,
for example, shared activities (e.g., a common
sales force, a common research and development
activity, a common manufacturing plant) (Barney,
2014) and shared core competencies (e.g., knowl-
edge developed in a business that can be used in
a second business) (Prahalad and Bettis, 1986;
Prahalad and Hamel, 1990). A rm that possesses
the kinds of resources and capabilities that can
generate such economies of scope can, according
to this logic, use related diversication to enhance
its value.
Copyright © 2015 John Wiley & Sons, Ltd. Strat. Mgmt. J.,38: 322–341 (2017)
DOI: 10.1002/smj
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