Diversification, Industry Structure, and Firm Strategy: An Organizational Economics Perspective

30 Pages Posted: 17 Apr 2009

See all articles by Peter G. Klein

Peter G. Klein

Baylor University - Hankamer School of Business; Norwegian School of Economics (NHH) - Department of Strategy and Management; Ludwig von Mises Institute

Lasse B. Lien

Norwegian School of Economics (NHH)

Date Written: April 16, 2009

Abstract

We review theory and evidence on corporate diversification, industry structure, and firm strategy from an organizational economics perspective. First, we examine the implications of transaction cost economics (TCE) for diversification decisions. TCE is essentially a theory about the costs of contracting, and TCE sheds light on the firm’s choice to diversify into a new industry rather than contract out any assets that are valuable in that industry. While TCE does not predict much about the specific industries into which a firm will diversify, it can be combined with other approaches, such as the resource-based and capabilities views, that describe which assets are useful where. We also discuss the transaction-cost rationale for unrelated diversification, which focuses on the potential efficiencies from exploiting internal capital markets. We review this argument as it emerged in the transaction cost literature in the 1970s and 1980s and, more recently, theoretical and empirical literature in industrial organization and corporate finance. We then discuss how diversification decisions, both related and unrelated, affect industry structure and industry evolution. Here, the stylized facts suggest that diversifying firms have a crucial impact on industry evolution because they are larger than average at entry, grow faster than average, and exit less often than the average firm. We conclude with thoughts on unresolved theoretical, methodological, and empirical issues and problems and provide suggestions for future research.

Keywords: diversification, transaction cost economics, the resource-based view, excess capacity, resource substitutability, resource complementarity, internal capital markets, industry evolution

JEL Classification: L25, G34, L11, D23, L14

Suggested Citation

Klein, Peter G. and Lien, Lasse B., Diversification, Industry Structure, and Firm Strategy: An Organizational Economics Perspective (April 16, 2009). CORI Working Paper No. 2009-03. Available at SSRN: https://ssrn.com/abstract=1387714 or http://dx.doi.org/10.2139/ssrn.1387714

Peter G. Klein (Contact Author)

Baylor University - Hankamer School of Business ( email )

Waco, TX 76798
United States
254-710-4903 (Phone)

Norwegian School of Economics (NHH) - Department of Strategy and Management ( email )

Breiviksveien 40
N-5045 Bergen
Norway

Ludwig von Mises Institute ( email )

Auburn, AL
United States

Lasse B. Lien

Norwegian School of Economics (NHH) ( email )

Helleveien 30
Bergen, 5045
Norway
+47 55959726 (Phone)

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