Multidivisional Strategy and Investment Returns

• DOI: http://doi.org/10.1111/jems.12018
• Published date: 01 September 2013
• Author: Gabriel Natividad
• Date: 01 September 2013

Multidivisional Strategy and Investment Returns

GABRIEL NATIVIDAD

New YorkUniversity, Stern School of Business

40 West Fourth St., Tisch Hall 723,

New York,NY 10012

gnativid@stern.nyu.edu

This paper studies the influence of multidivisional structure on investment returns using a large

database of projects in the U.S. film distribution industry, a setting in which divisionalization

exists without horizontal diversification—all divisions of multidivisional distributors release

feature films. The findings are consistent with a positive effect of multidivisional strategy on

investment returns, even if total investment need not increase. Multidivisional strategies are

more consequential for higher profitability when firms share key human talent across their

divisions.

1. Introduction

This paper provides an empirical investigation of the effects of multidivisional structure

on investment returns.Whether divisionalization pays off is a central question for strate-

gic managers, as the multidivisional form is one of the most common organizational

arrangements across many markets. Traditionally, the M-form has been conceptualized

as a feature of firms with a broad product market scope. However, in recent years com-

panies have increasingly pursued divisionalization strategies within a given industry. For

example, Newell Co. adopted a multidivisional configuration for its relatively uniform

product portfolio to exert more power over large clients such as Wal-Mart. Daimler-

Chrysler decided to maintain its automobile divisions separate after becoming a merged

entity to protect the different positioning of its brands. Walt Disney acquired Miramax

and kept it as a separate division in the film distribution industry. More broadly, the

value consequences of this growing practice cannot be assessed in the context of classic

work (e.g., Chandler, 1973; Rumelt, 1974; Hoskisson, 1987; Freeland, 1996) that, though

insightful, has not distinguished whether divisionalization, rather than horizontal di-

versification, influences economic outcomes (Sanzhar, 2006). This paper attempts to fill

that gap by closely examining how divisionalization influences investment returns.

There have been two central impediments to testing hypotheses about the invest-

ment returns of multidivisional firms. First, the diversity of investment opportunities

across corporate divisions makes cross-industry studies overly reliant on crude mea-

sures of divisional investments, thus creating substantial measurement error (Chevalier,

2004). Second, data on within-firm variation in organizational form (i.e., multidivisional

I thank Tony Bernardo, Marvin Lieberman, and Olav Sorenson for their guidance and support. I also wish

to thank Ashwini Agrawal, Kenneth Ahern, Judy Chevalier, Darlene Chisholm, Ricard Gil, Deepak Hegde,

Julia Liebeskind, Joe Ostroy, Toni Whited, Maggie Zhou, and audiences at NYU Stern, UCLA Anderson,

Universidad de Piura, the American Finance Association, and the International Society of New Institutional

Economics for helpful comments. Special thanks to Hong Luo for generously facilitating access to data on

movie ideas for supplementary tests. Errors are all mine. This paper previously circulated under different

titles.

C2013 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume22, Number 3, Fall 2013, 594–616

Multidivisional Strategy and Investment Returns 595

strategy) are typically not available for the population of firms or for a long time series,

thus leading to sample selection problems. This paper attempts to overcome both prob-

lems by analyzing how a multidivisional strategy affects the investment returns of film

distribution companies using micro data on the population of firms between 1985 and

2009.

The feature film distribution industry in the United States lends itself naturally

to studying the investment and performance implications of divisionalization in the

M-form for three key reasons. First, the detailed costs (investments) and revenues of

thousands of projects are separately observable, thus allowing for a closer look into how

different divisions of the same firm invest and obtain profits in productmarkets. Second,

the film distribution industry allows for the study of divisionalization holding horizontal

diversification fixed.1Specifically, several film distributors pursued corporate acquisi-

tions and internal developments, and subsequently operated in the industry through

two different types of divisions: major and specialty. Because all firms are observed before

and after adopting the M-form, the consequences of this multidivisional strategy can

be assessed using distributor fixed-effects regressions of investment and returns. This

focus on changes occurring to the same firm as it transitions from the U-form to the M-

form helps avoid possibly confounding factors hidden in a cross-section. Third, detailed

information is available on each project’s human talent and narrow market niche, thus

helping explore the causal mechanisms linking multidivisional strategy and investment

returns more directly.

The impact of multidivisional strategy on investments, revenues, and returns is

tested here mainly using project-level and firm-year-level fixed-effects regressions. The

relationships in the data are consistent with a positive effect of multidivisional strategy

on investment returns. Specifically, across the different levels of data aggregation in the

analysis, film distribution companies that are divisionalized achieve higher box office

revenues and higher overall returns. Interestingly, a multidivisional strategy does not

necessarily imply larger investments, thus challenging the notion that a principal mech-

anism for higher returns is more generous capital allocation. These panel fixed-effects

findings are confirmed using nonparametric matching models that compare projects of

multidivisional firms with projects of unidivisional firms, matching observations exactly

on each film’s year of release and thematic genre, and approximately on several firm-

and project-level characteristics.

The results also reveal that divisionalization increases returns through an internal

labor mechanism mostly discussed in theory or case studies that has received little

empirical attention. Specifically, multidivisional strategies are more consequential for

higher profitability when firms share key human talent—film producers—across their

different divisions, consistent with the logic that input-sharing can create synergies

(e.g., Dessein et al., 2010), especially when talented individuals can signal their higher

value more easily in the M-form (Harstad, 2007). Relatedly,multidivisional distribution

companies seem to provide incentives to star talent to participate in their projects,

though not necessarily through higher pay. Finally, alternative mechanisms such as a

stronger concentration on genre niches or changes in the project selection processes

that hypothetically could be enacted in a multidivisional structure are not supported

1. In the strategy literature, the primary interest in distinguishing divisionalization from diversification is

centeredon horizontal diversification (Chandler, 1973), a distinction that can be made using multidivisional data

in which different divisions do the same thing in the same market, as is the case in theatrical film distribution.

The paper provides some institutional facts and empirical tests confirming that examining divisionalization

in isolation from horizontal diversification is warranted in this empirical setting.