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Efficient Corporate Diversification: Methods and Implications

Author

Listed:
  • Raphael Amit

    (J. L. Kellogg Graduate School of Management, Northwestern University, Evanston, Illinois 60208)

  • Joshua Livnat

    (Graduate School of Business, New York University, New York, New York 10006)

Abstract

This study develops and tests a measure of efficient corporate diversification (ECD) that compares the variability of a firm's revenues with the variability of a minimum-variance portfolio of businesses that maintain the same sales growth rate. According to ECD, which incorporates the exposure of a firm to business cycle fluctuations, a firm is considered more efficient the higher its ratio of minimum variance to the realized variance. The empirical results indicate that efficient diversifiers manage to reduce the variability of their returns without sacrificing profitability. Moreover, such firms have a more favorable trade-off between risk and return in the equity market. Further, efficient diversifiers are found to be less diversified as measured by the extent of operations in different SIC industries. Instead, they operate in related business segments that have differential responses to business cycle changes and thereby enjoy the benefits from related diversification while minimizing their operating risk.

Suggested Citation

  • Raphael Amit & Joshua Livnat, 1989. "Efficient Corporate Diversification: Methods and Implications," Management Science, INFORMS, vol. 35(7), pages 879-897, July.
    • Handle: RePEc:inm:ormnsc:v:35:y:1989:i:7:p:879-897
    DOI: 10.1287/mnsc.35.7.879
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    Citations

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    Cited by:

    1. Hamadi, Malika & Heinen, Andréas, 2015. "Firm performance when ownership is very concentrated: Evidence from a semiparametric panel," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 172-194.
    2. Frantz Maurer, 1999. "L'influence des fluctuations boursières sur la performance financière de la firme diversifiée," Revue Finance Contrôle Stratégie, revues.org, vol. 2(4), pages 105-134, December.
    3. Palich, Leslie E. & Carini, Gary R. & Seaman, Samuel L., 2000. "The Impact of Internationalization on the Diversification-Performance Relationship: A Replication and Extension of Prior Research," Journal of Business Research, Elsevier, vol. 48(1), pages 43-54, April.
    4. Anandhi S. Bharadwaj & Sundar G. Bharadwaj & Benn R. Konsynski, 1999. "Information Technology Effects on Firm Performance as Measured by Tobin's q," Management Science, INFORMS, vol. 45(7), pages 1008-1024, July.
    5. Mouri, Nacef & Sarkar, M.B. & Frye, Melissa, 2012. "Alliance portfolios and shareholder value in post-IPO firms: The moderating roles of portfolio structure and firm-level uncertainty," Journal of Business Venturing, Elsevier, vol. 27(3), pages 355-371.
    6. Eriksen, Bo & Knudsen, Thorbjorn, 2003. "Industry and firm level interaction: Implications for profitability," Journal of Business Research, Elsevier, vol. 56(3), pages 191-199, March.
    7. Yue Maggie Zhou & Weikun Yang & Sendil Ethiraj, 2023. "The dynamics of related diversification: Evidence from the health insurance industry following the Affordable Care Act," Strategic Management Journal, Wiley Blackwell, vol. 44(7), pages 1753-1779, July.
    8. Andreas Bausch & Frithjof Pils, 2009. "Product diversification strategy and financial performance: meta-analytic evidence on causality and construct multidimensionality," Review of Managerial Science, Springer, vol. 3(3), pages 157-190, November.
    9. Wright, Peter & Kroll, Mark & Pray, Bevalee & Lado, Augustine, 1995. "Strategic orientations, competitive advantage, and business performance," Journal of Business Research, Elsevier, vol. 33(2), pages 143-151, June.

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