Virtuous or vicious cycles? The role of divestitures as a complementary Penrose effect within resource‐based theory

• Author: Will Mitchell,Elena Vidal
• Date: 01 January 2018
• Published date: 01 January 2018
• DOI: http://doi.org/10.1002/smj.2701

RESEARCH ARTICLE

Virtuous or vicious cycles? The role of divestitures

as a complementary Penrose effect within resource-

based theory

Elena Vidal

1

| Will Mitchell

2

1

Narendra P. Loomba Department of

Management, Baruch College–CUNY, Zicklin

School of Business, New York, New York

2

Strategic Management Department, Rotman

School of Management, University of Toronto,

Toronto, Ontario, Canada

Correspondence

Elena Vidal, Narendra P. Loomba Department of

Management, Zicklin School of Business, Baruch

College, The City University of New York, One

Baruch Way, New York, NY 10010.

Email: elena.vidal@baruch.cuny.edu

Funding information

Research Foundation of The City University of

New York, Grant/Award number: PSC-CUNY

Award #46; The City University of New York; The

Professional Staff Congress

Research summary:Studies of how divestitures affect

firm performance offer mixed results. This paper unpacks

relationships between divestitures and subsequent perfor-

mance, focusing first on the moderating role of prior per-

formance and then on mechanisms through which

divestitures by higher- and lower-performing firms affect

performance. The study suggests that divestitures can

exacerbate weakness and reinforce strength: divestitures

by lower performers improve profits but inhibit sales

growth and tend to speed the firms’exits as independent

actors; by contrast, higher-performing divesters invest in

support of existing assets and gain new growth, while

avoiding becoming acquisition targets. Most generally,

divestitures help reduce constraints to changing a firm’s

resource base, which we refer to as a complementary Pen-

rose effect.

Managerial summary:Divestitures help both struggling

firms and high performers free financial and managerial

resources that they can reinvest in more productive

uses. In doing so, divestitures reinforce the strength of

high performers but may exacerbate weaknesses of

struggling firms. Divestitures by lower performers

improve their profits but inhibit their sales growth and

increase the chances that the firms will be acquired. By

contrast, higher-performing divesters gain new growth

by investing in support of existing and recently

acquired assets and, by doing so, are less likely to

become targets of acquirers who seek their productive

assets. Thus, divestiture is part of a downward cycle

for struggling firms but supports a virtuous cycle for

superior firms.

Received: 22 July 2015 Revised: 25 July 2017 Accepted: 28 July 2017 Published on: 13 November 2017

DOI: 10.1002/smj.2701

Strat Mgmt J. 2018;39:131–154. wileyonlinelibrary.com/journal/smj Copyright © 2017 John Wiley & Sons, Ltd. 131

KEYWORDS

complementary Penrose effect, divestitures, firm

performance, performance feedback, resource-based

theory

1|INTRODUCTION

Strategy scholars have long been interested in the mechanisms through which firms shape their per-

formance. Resource-based theory posits that ongoing changes to resource bases via addition, dele-

tion, and/or recombination of components (Karim, 2006; Karim & Capron, 2015) can both help

firms address low performance and create new competitive advantages for high performers

(Helfat & Eisenhardt, 2004; Helfat et al., 2007; Moliterno & Wiersema, 2007). Traditional argu-

ments highlight the idea that improvements to performance, such as profitability and growth, are

bounded by the availability of a firm’s financial and managerial resources (Penrose, 1959); however,

we have only begun to investigate the mechanisms by which firms engage in activities to free up

resources and seek profitable growth opportunities. This paper focuses on divestitures, exploring

(a) how the performance of low and high-performing firms changes following divestitures,

(b) which resources divestitures free, (c) where firms reinvest freed resources, and (d) how the

investments affect firms’ongoing survival. In doing so, we develop the idea that divestitures help

free resources; this idea complements the traditional Penrosian view on resource-based growth.

Our exploratory study draws from and contributes to resource-based theory (Wernerfelt, 1984;

Barney, 1991) and its related dynamic capabilities arguments (Helfat et al., 2007) to shed light on

how divestitures shape subsequent performance and new investment. We build on Penrose’s argu-

ment that firms can generate profitable growth by drawing on their resource base, with constraints

arising from limits to financial resources and managerial capacity (Penrose, 1959, pp. 142–144).

What this argument has not fully addressed is the idea that firms can seek to create additional finan-

cial and managerial capacity. We extend the traditional argument to suggest that divestitures are part

of a complementary Penrose effect, in which firms eliminate existing resources and reinvest money

and attention in higher potential opportunities for growth. These opportunities allow low performing

firms to address their low performance and high-performing firms to invest in areas that maintain

their superiority.

The idea of a complementary Penrose effect provides relevant concepts to frame our investiga-

tion of how firms might invest resources freed by divestitures to support future performance. How-

ever, this perspective does not yet offer sufficiently fine-grained logic to motivate precise

hypotheses concerning the effects of the investments, particularly regarding possible differences in

diverse aspects of strategic activity when firms divest from positions of higher or lower perfor-

mance. Rather than attempting to build hypotheses that rely on logical arguments that would inevita-

bly contain substantial ambiguity, we develop research questions concerning divestitures,

subsequent performance, and investments that may link divestitures to the observed subsequent per-

formance. The empirical exploration provides a base for further conceptual development, including

a focal set of propositions.

132 VIDAL AND MITCHELL