Diversification and Firm Performance
DIVERSIFICATION AND FIRM PERFORMANCE:
AN EMPIRICAL EVALUATION
Anil M. Pandya and Narendar V. Rao
Abstract
Diversification is a strategic option that many managers use to improve their firms’ performance. This interdisciplinary research attempts to verify whether firm level diversification has any impact on performance. The study finds that on average, diversified firms show better performance compared to undiversified firms on both risk and return dimensions. It also tests the robustness of these results by classifying firms by performance class. The results show that among the best performing class of firms, undiversified firms have higher returns, but these returns are accompanied by high variance. Whereas, highly diversified firms show lower returns, and much lower variance. Results further show that diversified firms perform better than undiversified firms on risk and return dimensions, in the low and average performance classes. The paper concludes that a dominant undiversified firm may perform better than a highly diversified firm in terms of return but its riskiness will be much greater. If managers of such firms opt for diversification, their returns will decrease, but their riskiness will reduce proportionately more than the reduction in their returns. In such firms, there will be a tradeoff between risk and return.
INTRODUCTION
Two seemingly irreconcilable facts motivate this study: one, diversification continues to be an important strategy for corporate growth; and two, while Management and Marketing disciplines favor related diversification, Finance makes a strong case against corporate diversification. With the help of a large sample, this interdisciplinary study tries to address this contradiction in the associative relationship between diversification and firm performance.
Diversification is a means by which a firm expands from its core business into other product markets (Aaker 1980, Andrews 1980, Berry 1975, Chandler 1962, Gluck 1985).
AN EMPIRICAL EVALUATION
Anil M. Pandya and Narendar V. Rao
Abstract
Diversification is a strategic option that many managers use to improve their firms’ performance. This interdisciplinary research attempts to verify whether firm level diversification has any impact on performance. The study finds that on average, diversified firms show better performance compared to undiversified firms on both risk and return dimensions. It also tests the robustness of these results by classifying firms by performance class. The results show that among the best performing class of firms, undiversified firms have higher returns, but these returns are accompanied by high variance. Whereas, highly diversified firms show lower returns, and much lower variance. Results further show that diversified firms perform better than undiversified firms on risk and return dimensions, in the low and average performance classes. The paper concludes that a dominant undiversified firm may perform better than a highly diversified firm in terms of return but its riskiness will be much greater. If managers of such firms opt for diversification, their returns will decrease, but their riskiness will reduce proportionately more than the reduction in their returns. In such firms, there will be a tradeoff between risk and return.
INTRODUCTION
Two seemingly irreconcilable facts motivate this study: one, diversification continues to be an important strategy for corporate growth; and two, while Management and Marketing disciplines favor related diversification, Finance makes a strong case against corporate diversification. With the help of a large sample, this interdisciplinary study tries to address this contradiction in the associative relationship between diversification and firm performance.
Diversification is a means by which a firm expands from its core business into other product markets (Aaker 1980, Andrews 1980, Berry 1975, Chandler 1962, Gluck 1985).