Antecedents of diversification: perspectives from theories of firm

Abstract

The managers and consultants in the West continue to dismantle conglomerates and refocus the mildly diversified firms; however the large, diversified firms and business groups continue to remain a dominant from in emerging markets like India. Several theoretical explanations have already been offered to this phenomenon. This is not surprising given that diversification is also one of the most extensively researched topics in the fields of strategic management, industrial organization, and more recently, corporate finance. What is noteworthy, however, is that the empirical evidence about this question is still scant. Most of the empirical evidence provided about diversification motives has been indirect, through the study of diversification’s effect on corporate performance. Few empirical analyses exist on antecedents of diversification but these have ignored the emerging economy context like India.in this study, we seek to develop and empirically test an eclectic framework to identify and understand the determinants of diversification specifically suited to the institutional context prevailing in India. We also examine how the changing institutional context has influenced the diversification and relatedness of business in firms and business groups in India. A review of literature suggests that we need an eclectic approach that integrates institutional economics. The study uses a multi-level, multi-methodology research design for operationalizing the above framework. Considering the idiosyncrasies of the Indian context where group affiliated firms have independent shareholding and are not completely dependent on the group headquarters for decisions, we have conducted analysis at both firm and group level. Our multi methodology research design includes analysis of secondary data consisting of all the listed companies in India and a case study. The secondary data is gathered from Prowess database of Centre for Monitoring of Indian Economy for the period 1989-2003. We have employed fixed effects Probit model, which centers on movement between single segment and diversified category and fixed effects Tobit model, which focuses on movement within the diversified category, while statistically taking account of the single segment firms/groups, to analyze propensity of diversification and extent of diversification respectively. For the case study, we have analyzed all the diversification and refocusing decisions of Torrent group since its inception. We also access the relatedness between industries in the Indian context. We go beyond the conventional measures to assess the relatedness on counts other than product market relatedness. We also found that for both firms and business groups, the latter continues to be important even after more than a decade of reforms. Our descriptive results show that firms and business groups have changed both the nature and extent of their scope substantially after 1991, providing evidence for the policy Distortion view of diversification. Overall we found that diversification in India is not motivated by economies of scope in financial, brand, distribution and technological resources. Moreover, we also found that it is only the diversified firms and business groups that take advantage of the changing institutional context independent firms react to only serve macro-economic shocks. Among the theoretical perspectives that explain diversification in the Indian context, our results indicate high explanatory power to industrial organization perspective and institutional perspective. The study shows that high diversification in developing countries is not an anomaly; existing theories can explain it when the influence of institutional context on firm resources/capabilities and competition is taken into account.