1. Diversification

2. Introduction The great majority of firms operate in multiple output markets They are diversified to at least some extent Recent developments have, however, appeared to reverse this trend  firms are refocusing on core competencies Data are consistent with increased diversification to the late ‘60s and reduced diversification by 1990

3. Merger Waves Discern several waves Late 1880s - early 1900s  emergence of large trusts with monopoly power early 1920s  similar but leading to firms with lesser market power 1960s  emergence of large conglomerates 1980s  many takeovers intended to break up conglomerates 1990s  mergers in related businesses domestic and international

4. Rationales for Diversification Economies of scale and scope Financial synergies Economize on transactions costs Managerial motives

5. Economies of scale and scope Difficult to see a rationale for economies of scale across unrelated activities If there are to be economies of scope  products should be related in technology or in consumer markets  (Penrose) utilize managerial and organizational resources in new areas when growth in existing markets is constrained “Dominant general management logic”  management has specific skills that can be applied in different areas of activity  unconvincing!

6. Financial Synergies Long-term success requires a diversified portfolio of businesses to smooth out cash flows Use profits from one set of activities to underwrite others But  shareholders can diversify at least as effectively more cheaply (don’t have to buy the target company!)  “firm-as-banker” is unconvincing unless the firm is a bank  the “winner’s curse”  mergers with economies of scope give both production and financial synergies and so are preferable

7. Economize on Transactions Costs Why can scope economies not be achieved by independent firms? Diversification may be efficient if transactions costs inhibit coordination among independent units Particularly when production involves specialized assets  human capital  organizational routines But diversified firms are subject to influence costs  reduced ability to monitor divisions in different businesses  may not have the correct incentive structures to align managers

8. Managerial Motives to Diversify To maintain and enhance position of management  if shareholders cannot monitor managers Pursuit of growth  easier to grow by acquisition than by internal development  advantages of managing large growing firms  conglomerates emerge when there are constraints on related acquisitions To increase job security  diversified firm is less likely to underperform the market Implies that there are gains from monitoring management

9. Market for Corporate Control What limits management in pursuing their own agendas?  Threat of being replaced through hostile takeover  Corporate raiders in the 1980s replacing inefficient management “Market for corporate control”  control of corporations is a valuable asset  merger replaces one management team with another  threat of takeover disciplines management  requires that the raider has specialized knowledge and resources  particularly convincing with “bust-up hostile takeovers

10. Diversification and Efficiency MCC relies on capital market identifying and replacing inefficient management Who benefits?  If gains come from operating economies then the stakeholders should gain  If there are no operating synergies then wealth is transferred from stakeholders to the new owners extract quasi-rents from those with relationship-specific investments in the target firm  This can have long-term detrimental effects reduce willingness to make such investments

11. Diversification and Performance Extensive diversification is often associated with poor performance Stock market valuation is affected by diversification  unrelated acquisitions tended to bid away potential gains  to realize gains diversification must involve related business activities should use specialized and intangible resources of the parent company Diversified mergers have performed badly over time  mergers of the 1980s corrected conglomerate mergers of the 1960s For diversification to work the diversified firm must integrate its various activities effectively