PAPER 1 = synergy, coordination costs and diversification choices – Zhou (2011)
Transaction costs economics (= limits on the firm boundaries, it is where the firm would stop
diversifying) + agency theories
Divisible & indivisible resources will create synergies within-industry
Explicit knowledge = available for everyone
Tacit knowledge = not available for everyone, is very specific and sometimes patent
Key question = what factors determine the limits to diversification
Focus on related diversification;
- Input sharing as a source of both synergistic gains and coordination costs
o Input indivisibility
- The role of complexity as a factor limiting the diversification
Coordination costs offset the benefits for synergies
Topic & expected contribution = paper examines whether the pursuit of synergy itself explains limits
to related diversification. The gap that is filled by this study is examining whether firms endogenously
make their diversification decisions based on market opportunities, perceived potential synergy, and
coordination costs.
- Intriguing = shows new thoughts, dares to make bold moves and not afraid to deviate from
the existing findings / beliefs
- Innovative = it clearly shows answer to the gap that is highlighted in the present literature
and shows ways how to better examine and clarify this section
- Impactful = no future research suggestions or implications for scholars given
- Important = there are 2 implications that managers can use directly in the ‘field’
, Framing = The two papers treat the diversification decision differently: Rawley as exogenously driven
by market opportunities, while I examine whether firms endogenously make their diversification
decisions based on market opportunities, perceived potential synergy, and coordination costs.
- Literature gap is clearly discussed and addressed
- Paper uses both recent literature as the foundation of the theories used (varies between
1970 and 2009)
Theory development =
1. Hypothesis 1: A firm is less likely to diversify into a new business when its existing business
lines are more complex.
The insignificance is partly due to the industry dummies. It is also consistent with prior
conclusions (e.g., Silverman, 1999) that the characteristics of the primary industry are not as
significant as the characteristics of the firm and the target industry.
As suggested by Hypothesis 1, COMPLEXITY is negatively associated with diversifying entry.
Introducing COMPLEXITY also significantly improves the fit of the logit model, as evidenced by
the log-likelihood ratio test (χ2(1) = 55.86, p < 0.0001).
1) Hypothesis 2: A firm’s likelihood of diversifying into a new business decreases more with the
complexity in the firm’s existing business lines if they share more inputs with the new
business.
The coefficient is significantly negative, suggesting that input similarity magnifies the
negative relationship between complexity and the likelihood of diversifying entry.
Thus Hypothesis 2 is supported: a firm’s likelihood of diversifying into a new business
decreases more with complexity if the new business shares more inputs with the existing
business lines.
Methods = Empirical design information;
- Hypotheses were tested using information on the business activities of US equipment
manufacturers in Standard Industrial Classification + diversifying entries into all
manufacturing industries between 1993 and 2003
- Time period = 1993 and 2003 (10 years)
o Companies 1599 publicly traded and diversified US companies
- Level of analysis is firm year for each standard industrial classification target industry
- Data is gathered form existing business activities
- Dependent variable = ENTRY
- Firm variables = complexity, input similarity (size, scope, geographic dispersion, age, past
performance, financial slack, capital intensity, etc),
- Sample = After 182 firms were dropped due to missing values, 965 firms remained in the
sample. There are 459 four-digit SIC manufacturing industries. Industry growth and
concentration information was available for 429 of them from the U.S. Bureau of Census.
Each of these 429 industries that a firm does not operate in the previous year is a potential
target for entry. The final sample contains 1,970,256 firm-year target industry observations
o Entry occurred in 808 of these (0.04%)
Argumentation author = This empirical setting is especially suitable because equipment
manufacturing entails multiple stages and requires large quantities of intermediate
inputs, which provides large variation in scope and complexity across firms in the same
primary industry.
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