Diversification strategy and systematic risk

• Published date: 01 April 1984
• DOI: http://doi.org/10.1002/smj.4250050208
• Date: 01 April 1984
• Author: Cynthia A. Montgomery,Harbir Singh

Strategic Management Journal,

Vol.

5,

181-191 (1984)

Diversification Strategy and Systematic

Risk

CYNTHIA A. MONTGOMERY

and

HARBIR SINGH

Graduate School

of

Business Administration, The University

of

Michigan, Ann Arbor, Michigan, U.S.A.

c

4

Summary

This paper addresses the relationship bet ween diversijication

strategy and systematic risk (be fa). Beta values are examined for six

divers8cation categories, and

if

is found that betas $or uncelated

diversiJers are signiJcantly higher than those

of

other !firms.

Possible contributions to this diference, including market

~9

wer,

capital structure, and capital intensity are explored.

FIRM DIVERSIFICATION AND SYSTEMATIC RISK

The focus of business policy on the tasks of the general manager and the responsibilities of

top-level policy-makers in corporations leads naturally to a consideration of corporate

diversification. In this perspective, diversification issues relate to the question of what set of

businesses to be in and how to manage the linkages among those businesses: Corporate

finance literature has also examined the issue of diversification, emphasizing the value a

shareholder might expect from

a

firm’s diversification moves. In a first attempt

to

link

empirically these two traditions, the present paper applies

a

financial criterion to a strategic

typology of diversification. Specifically, the paper examines the relationship between

diversification strategy and systematic risk, providing a market risk evaluation of various

diversification profiles.

From the policy perspective, evaluation of firm diversification has emphasized

a

consideration of the distinctive strengths of

a

firm, and the extent to which those strengths

are involved

in

various expansion moves (e.g. Rumelt,

1974;

Montgomery,

1979).

Discussion here has centred

on

related versus unrelated diversification, the key issue being

whether or not

a

firm’s businesses are related from a strategic point of view. In this sense,

relatedness could involve the firm’s manufacturing processes, marketing requirements,

research issues, or managerial tasks. The potential for synergies in any or all of these areas,

and the activity required to realize the same, is of considerable importance to a firm’s top-

level management. From an internal perspective, these managers are concerned not only

with the potential pay-offs from

a

diversification move, but also with the great implications

such moves present for managing the firm and determining its long-term future.

The finance perspective, which emphasizes long run profit maximization, evaluates

alternative strategies, including those of diversification, from the common stockholders’

point

of

view. Here the principal concerns are the return

on

the stock and the associated risk

of holding the stock.

A

manager’s task in this perspective can be abstracted to that of

providing the shareholder with the greatest return for

a

given amount

of

risk.

0143-2095/84/02018

1-

1

l%Ol

.

10

Received

I0

November 1982

0

1984

by

John

Wiley

&

Sons,

Ltd.

Revised 9 June 1983

,