Diversification, Refocusing, and Economic Performance.

• Author: Sandler, Ralph

Since the 1980s news of megamergers, hostile takeovers and proxy fights have been extensively reported in the business press. There is, however, rising evidence that many U.S. corporations have attempted to reduce the scope of their activities in order to concentrate on their "core business." This reduction in the diversification of U.S. firms, which has gone almost unnoticed and is referred to as "refocusing," is the subject of this ambitious study by Professor Markides. The book is based on his doctoral dissertation at the Harvard business school. Portions of his research have already been reported in academic journals.

The central proposition of the book is that every firm has a limit to how much it can diversify. That limit can be formulated in terms of marginal benefits and marginal costs. There is an optimal point beyond which the costs outweigh the benefits of additional diversification. According to Markides:

Every firm has a different optimal limit depending on its resources, its external environment, the type of diversification it is following, the caliber of its management team, its past diversification experiences, whether any learning occurred from other diversification experiences, and so on [p. 16].

Primarily because of agency problems, but also for other reasons, many firms have diversified beyond what is optimal in recent years. This has adversely effected profitability and market value. Certainly an overview of historical patterns appears to reinforce this view as an increasing number of american firms were refocusing in the 1980s [p. 47]. The author suggests that a stronger market for corporate control (in the 1980s) has provided the impetus for this phenomenon [p. 29].

Consistent with the view that firms do have a limit to how much they can diversify, Markides found that firms were much more likely to refocus if they were highly diversified, had an attractive core business to begin with and were responding to a performance crisis. In fact, he says that many of these firms (in the 1980s) were probably responding to the threat of a hostile takeover [p. 29].

One of the most important questions that the author attempts to answer empirically is whether refocusing has an impact on the market value of a firm. One would expect the stock market to respond favorably to an announcement that an excessively diversified firm planned to restructure. A sample of forty-five firms were examined using an event-study methodology. As theory...